Time to take stock. This dratted credit crunch has now celebrated, if
that’s the word, its first birthday, and there is no clarity about when it
may end. What’s a law firm to do?
If you believe McKinsey, and if you believe that where investment bankers
go, law firms will follow, the answer is: Look to the emerging
markets.
Relying on the results of the McKinsey "Global Capital Markets Survey," which
purports to forecast estimates of investment banking revenue for the years
2007 to 2010, the message is that:
- Emerging Asia,
- Emerging Europe,
- The Middle East, and
- Latin America
will probably show absolute revenue growth over the next three years and under
what they call "all likely outcomes," emerging markets’ share
of global revenues will "jump sharply." Here’s the soundbite:
Collectively, indeed, revenues from investment-banking and capital market
activities in these regions are projected to match those in North America by
2010; in 2006, before the credit crunch, they amounted to less than half. A
case, perhaps, for referring to “emerged†rather than emerging markets in the
future?
Uncertainties, to be sure, abound. Primary factors determining when
the credit crunch may ease include the overall macroeconomic prospects for
growth in the US and developed economies; investors’ behavior–simply put, when and to what extent confidence comes back; regulators’ behavior (do they over-react and clamp down in market-suppressing ways); and of course the grand-daddy
unknowable of them all, namely when the credit and liquidity lockup will start
melting as the lending institutions in the economy begin to see clarity about the future and are able to restore their balance sheets to health.
But back to the emerging markets.
Why are they so attractive at this juncture in the economic cycle? For one thing, as McKinsey alluded to above ("emerged" vs. "emerging"), they’re already getting sophisticated (emphasis supplied):
First, their macroeconomic environment remains comparatively benign, even if talk of a complete “decoupling†of their economies from those of the United States and Western Europe was premature. Although, if trade flows with the West do suffer, regional demand for oil and commodities, growing intra- and interregional trade flows (especially within Asia and between it and the Middle East), and huge infrastructure-investment programs will continue to underpin growth.
Second, a new breed of global corporate players, notably in countries such as China, India, and the United Arab Emirates (UAE), now demands the sort of sophisticated investment-banking services [and concomitant legal services] previously reserved for large Western multinationals. This new group thus represents an increasingly attractive fee pool.
Add to that that they’re less exposed to the infamous credit crunch. For example, if writedowns is your blunt-instrument measure of exposure, investment banks have written down only about 7% of their revenues from emerging markets as opposed to three times that–21%–on a global basis.
Two other reinforcing trends are in play. First, certainly in Asia, economies are growing, pure and simple, on their own. That just increases the stock of financial instruments and their tradability. But second, as Asia becomes increasingly integrated with the global economy, inbound and outbound investment will increase, and it will take increasingly sophisticated forms. For "sophistication," substitute "lawyer-heavy," and you have a reason to take this region more seriously.
Do you have to be there?
I believe you do. But let McKinsey speak to this:
Asian markets are fast becoming as demanding and sophisticated as markets in Europe and the United States. Clients have developed a taste for complex financial products and demand good local service; domestic competitors are ramping up their skills and opening their checkbooks to attract international talent.
An onshore presence in emerging Asian markets, meanwhile, is becoming critical. The old model of the suitcase banker operating from hubs such as Singapore and Hong Kong will fail to satisfy clients and regulators seeking a true commitment to the local market.
I’ve observed before that in America the first "real" question people ask a new acquaintance is, "What do you do?" In the UK it’s "Where did you go to school?" And in China it’s "Where are you from?"
Not to be cute, but if this is remotely correct (and I’ve reality-tested it with numerous people in all three areas), you really need to be on the ground in Asia to manage inbound or outbound investments more than you need to be on the ground in (say) Silicon Valley to manage a high-tech IPO or Brussels to handle an EU regulatory matter.
So much for Asia. What about Eastern Europe?
In a nutshell, McKinsey sees overall annual GDP growth from 7% (in their "darker" scenario) to an astonishing 19% in their "more benign" scenario. I’ll take some of that, thank you very much.
The only trouble with this area, for law firm land (as opposed to investment banking land), is that the primary source of increased fee revenue McKinsey foresees has almost all to do with sales and trading: "In the future, we believe, growth will probably shift from foreign exchange to interest- and equity-based derivatives, among other products."
And the Mideast?
No surprises here: Investment banks are redeploying more and more professionals from New York and London to the region:
The oil-rich states of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE—are generating wealth at levels not seen since the 1980s. High oil prices have triggered an unprecedented wave of investment, including a huge pipeline of industrial and large-scale infrastructure projects, such as Saudi Arabia’s new “economic cities.†By some accounts, the GCC will have invested around $3 trillion in the region by 2020.
Can you afford to miss this?
That is for your firm to call, including your partners’ appetite for risk and their willingness to endure a period of potentially protracted investment, but the historic shift of momentum seems clear:
Emerging markets now have a rare window of opportunity to catch up with the rest of the world, not least because they don’t have to mitigate the mess created by current market dislocation in the West.
Here we have, in other words, the flip-side of the credit market and liquidity freeze.
Stung (perhaps severely?) by that meltdown? Here (the good news) is an enormous, far more durable, opportunity. But (the bad news) if you are still bleeding from overexposure to the frozen credit markets, you may not be in a position to make the requisite investments half a world away.
Don’t ever again think that managing a law firm is an exercise in quarter to quarter or year to year performance.
The transition from "emerging" to "emerged" will take a few decades. You need to have the same time horizon.
Update: Mon 1 Sept.
The September issue of The American Lawyer (published online today)
has a lead story, "No
More Pure Plays," attempting to apply lessons learned
by law firms sideswiped (or worse: see Brobeck) by the dot-com
meltdown in 2000—2001 to today’s market where securitization and structured
finance have experienced a similar sickening sensation of the trap door opening
beneath them.
The first thing to be said about these types of market tops is simply this: "In
hindsight, the folly of it all seems obvious. But here we are again."
And, as Stephen Neal, managing partner of Cooley Godward Kronish from early
2001 through today puts it with commendable clarity: "In retrospect
you might say [the growth] was a mistake, but we didn’t know at the time how
long this market would last. At the time it was almost irresistible."
The "almost irresistible" comment brings to mind the business classic, The
Innovator’s Dilemma, where Prof. Clayton Christensen of Harvard
Business School set out a coherent, compelling, and historically astute view
of just how the most powerful incumbents in any given industry are
precisely the firms most vulnerable to maverick upstarts with what appear
at first glance to be second- or third-tier offerings of no conceivable utility
to the incumbents’ core customers. While it might seem intuitive that
the most knowledgeable, most strongly capitalized, most sophisticated firms
in an industry would be theones most capable of exploiting innovations "in
their own backyard," as it were, Christensen demonstrates precisely the opposite
is more common. Incumbents suffer from:
- Being excessively loyal to their core, established clients (yes,
even client loyalty can be pushed too far, when it becomes a limitation rather
than a strength); - Focusing on continuous incremental improvements to their existing product
or service offerings, while being blind to "disruptive" innovations; and
finally and most tellingly of all - Being unable to abandon extremely profitable existing lines of business
to take a chance on an unproven innovation whose value will only be known
in some indeterminate future time.
It’s the final point that Mr. Neal is echoing, and it’s the seductive power
of any boom: When the getting is good, the getting is very good indeed. (Or,
as The Onion recently facetiously headlined, "Americans Reeling from
Housing Meltdown Seek Next Bubble to Invest In.") Some of the key
Silicon Valley firms grew as follows—and this doesn’t include all the
firms from elsewhere in the country that starting piling willy-nilly into Northern
California just as the window was about to slam shut on their fingers:
- Cooley added 300 lawyers in a 12 to 18 month period;
- Wilson Sonsini went from 550 to 812; and
- Brobeck from 540 to 724.
Even at that torrid pace (let’s not even think about quality control, shall
we not?), "’We turned away nine out of ten pieces of business–maybe more,’
said Mark Tanoury, who then headed Cooley’s business group, in 2000."
Still, the article finds reason for optimism this time around, at least as
compared to the carnage at the start of this decade. Why? Primarily
because the NY-centric firms that doubled down on securitization have been
far quicker to wield the "scythe" with associates. To this
day, Wilson Sonsini has never publicly admitted that it laid off associates,
although, mirabile dictu, its headcount shrank from 812 in 2000 to
540 in 2004, and the beginning of the end of Brobeck, at least as the received
wisdom has it, came when Tower Snow refused to lay off associates.
The article gives, indeed, the last word to Mr. Snow: "History
shows that those who are overconfident or arrogant tend not to do well when
the environment changes." Ironic, and prescient, words indeed.
But I choose to give the last word to Chris White, chairman of Cadwalader,
who told The Wall Street Journal last month:
"There was a bubble, we rode that bubble, it contracted, and we adjusted.
Even knowing what I know now, I wouldn’t have changed a thing,"
The cynics in the audience may judge that chutzpah of the highest
order. But I for one see it differently, and give Mr. White great credit
for a shockingly salubrious spasm of candor.
Now the only question will be whether their "adjustments" have been rapid
and strong enough.
