Recent events on Wall Street and the subsequent impact on the global finance sector may mean more than the loss of a few big clients for the “magic circle” firms internationally, say some. It may mean re-evaluating their entire international business models.

The collapse of the US investment banking system, including the filing for bankruptcy protection by Lehman Brothers as well as the hasty merger of Merrill Lynch with Bank of America and the bailout of the world’s largest insurer AIG, have left the Iberian markets and law firms in a state of shock. The Spanish and Portuguese Governments have sought to inject confidence, and liquidity, into the domestic financial systems and to distance their financial institutions from the resulting market tsunami but financiers and law firm partners alike have been anxious to ascertain what impact the drama may have on their businesses.

The international strategies of the London “magic circle” and other City-based law firms have to a large extent been underpinned, and underwritten, by the global investment banks. What now for them and their international operations, including those in Iberia? And what may be the likely repercussions on Iberia’s domestic law firms, which at first glance would appear to be largely immune to the events in Wall Street?

Immediate impact

The collapse of the US-led investment banking system, and the resulting chaos in the international capital markets, will, some suggest, have had a significant impact on the banking and finance, M&A and tax departments of a number of the leading law firms in Spain, especially the international ones.

“You only have to look at the legal directories to see that Lehman alone spread its mandates for legal work quite widely,” a senior Madrid source told Iberian Lawyer. “We had a lot of files open for them and are only now coming to realise that we are in a long line of people with unpaid bills.”

Previous law firm advisers to Lehman in Iberia include Allen & Overy, Ashurst, Clifford Chance, Linklaters, Lovells and Uría Menéndez. Linklaters is also known to have previously acted for Merrill Lynch, while Clifford Chance, DLA Piper and Freshfields have all represented Bank of America locally.

Law firm managing partners are inevitably therefore trying to ascertain where they stand as creditors and whether work in progress for Lehman will transfer to another investment bank, and therefore possibly to another legal adviser. Some law firms have, off the record, told Iberian Lawyer that the events unfolding over recent weeks may leave them facing a substantial financial hit.

Some calculations suggest that, globally, several of the magic circle firms were billing each of their closest investment banking clients over £40m annually and only slightly less from other investment banks. If true, these firms may be seeing a hole emerging in their accounts of anywhere between £100m-£150m – equivalent to almost 10% of annual turnover.

Short-term fix

In the short-term however, many of the London-based international firms seem to be coping with events with a number even picking up significant mandates as a direct result of the collapse of their previous clients.

Ashurst is advising Lehman Brothers on its European bankruptcy (alongside Weil Gotshal Manges in the US), while Linklaters’ London office has been retained by PricewaterhouseCoopers (PwC) to coordinate the European administration proceedings – with a reported 20-partner, 60-associate, team now engaged. Linklaters’ Brussels office is also representing Fortis, following its near collapse and the sale of its Belgian, Luxembourg and international operations to BNP Paribas (including those acquired last year in its joint €71bn takeover of ABN Amro). Allen & Overy is representing the Netherlands Government and Clifford Chance its Central Bank. Clifford Chance is also advising Barclays Bank on its acquisition of Lehman Brothers’ US brokerdealer operations (following an abandoned earlier analysis to acquire the entire bank).

Davis Polk & Wardwell, which has a small Madrid office, was retained by a consortium of ten banks – comprising Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley and UBS – which have jointly raised a $70bn credit facility to help ensure liquidity among themselves.

Other firms hope that the change of ownership at Merrill Lynch will mean business as usual across Iberia. “As for Bank of America's acquisition I see little change. To date it has had only a minimal presence here so there is every reason to believe that Merrill Lynch’s existing roster of firms will continue to be used. At least I hope so,” says one Madrid-based lawyer.

Deeper

The medium-term prospects may however be less certain, and a number of the magic circle firms are already known to be reassessing the relative emphasis of their international operations, including within Iberia.

Plateau partners’ earnings at magic circle firms last year were in the range of £1.2m (€1.5m) to over £2m (€2.5m) but the loss of the investment banking revenue alone could hit Profit Per Equity Partner (PEP) heavily. One expert told Iberian Lawyer that a 10% reduction in income without a subsequent reduction in costs, would reduce the profit pool and mean as much as a 25% reduction in PEP. In addition, firms are seeing increased pressure on their own loan and debt arrangements and cash flow may yet become an issue, suggest some. Deals are taking longer to conclude, clients are delaying settling their bills but lawyers salaries´ still have to go out each month.

“The City firms stopped making financial provisions for the bad times a number of years ago and instead put the emphasis on increasing partner earnings. Our costs though are fixed and it now looks like any loss will have to come out of the partners’ pool,” says one London source.

Some believe that, among the strategic options being considered, one is for firms to place build a stronger domestic client base, which means greater emphasis on clients outside Madrid. “There is no doubt that we now have to get out into the regions,” says one managing partner of a UK firm in Madrid. “We need to demonstrate to clients across the peninsula that we can assist them in their international expansion, to facilitate acquisitions and to open up new markets for them.”

Important also, suggest some, is that the UK firms may no longer be able to rely on the international banks to get them into the major domestic deals, and that they will instead have to start to choose sides in key business sectors.

Such developments will inevitably bring them into closer competition with the dominant domestic law firms. Nonetheless, some may be in a better starting position than others, say some.

Picking up work from regional Spanish clients is more easily said than done, confided one magic circle partner: “What can we offer over the strong domestic firms who have an unbeatable position outside Madrid? Persuading clients to leave their current advisors is not an easy proposition.”

Clifford Chance is regarded as already having a strong domestic profile, and is closer to Uría Menéndez in shape than Linklaters’ high deal value and underwriter-focused practice.

Conversely however, Linkaters’ compact 70- lawyer size arguably means that it requires less work than Clifford Chance’s 160-lawyer deal-hungry office.

Also compact in size is Freshfields, which has had significant local and international success advising Ferrovial, Abertis and Agbar (through its Barcelona office) and is acting for Gas Natural in its €17bn acquisition of Unión Fenosa. Allen & Overy, which some suggest is the most low-profile of the magic circle firms in Spain, is nonetheless also active on headline deals including acting for Iberia in the takeover by British Airways, and is advising Alliance & Leicester, the UK bank being acquired by Banco Santander.

Yet some say that if the magic circle firms go deeper into the local mid-market, pressure will inevitably be put on the other London-based law firm players, as well as the new US arrivals such as Latham & Watkins.

“The magic circle will always do well. They have strong international brands, are well known locally, and will likely benefit from any ‘flight to quality’. If I was a lawyer at another English firm like Simmons & Simmons, Ashurst or DLA Piper, then I might be more worried,” one Madrid lawyer commented.

These mid-tier firms inevitably counter such suggestions and highlight their already established efforts to build strong domestic practices and profiles. Simmons & Simmons’ 2007 integration with respected litigation and insolvency firm Mochales & Palacios arguably gave it a strong local client base and lead over other firms’ countercyclical practice development.

The start of the downturn has also seen Ashurst very busy on refinancing and especially advising on distressed debt. “Call it good timing or luck, but we have been promoting our distressed debt practice for 18 months already, and in the last few weeks have been approached by a number of domestic banks to advise them on potential opportunities,” adds Gonzalo Jiménez-Blanco, Managing Partner at Ashurst in Madrid.

Domestic situation

Within the leading domestic firms there is also a strong belief that they will be able to counter any increased threat posed by the magic circle firms as they look to deepen their domestic client portfolios. “UK firms have been here for 25 years already and we’re clearly still in business,” says one Madrid firm partner.

A number of Spanish firms emphasise the strength of their national networks. Madrid may be Spain’s most profitable legal centre but clients across the regions are now requiring heavyweight legal advice and making an ever-greater impact on billing levels.

“When the economy is not doing so well it puts extra importance on our regional practices where it clearly helps that our lawyers reflect their clients: in Valencia they are Valencian and in Barcelona they are Catalan. It helps demonstrate that we are committed to the local economies and are there for the long-term,” says Juan Agoya, a corporate partner at Cuatrecasas in Madrid.

The perception among some in the capital is that many of Spain’s regional firms may indeed now be doing very well. “Firms like Broseta in Valencia must be doing the work of their lives. They are so deeply connected that there is no way we can win clients away from them,” says a partner at one magic circle firm.

Yet the same size and scale that enables firms to reach across Iberia may nonetheless present problems if the economy takes a dramatic downturn, suggest others. Garrigues, with 1,500 lawyers has too many mouths to feed, says one partner at a rival firm.

Greater emphasis will have to be placed on partners to go and find work, suggest some. But under-performance is an issue that many domestic firms have failed to tackle in recent years and which may now come back to haunt them.

“Financial reporting is black and white and we know who has billed what but we are still avoiding doing anything about it. In the bad years it makes the issue even more difficult, more personal and more political,” says the managing partner of one firm in Madrid.

It is no surprise that greater competition may also bring increased fee pressure, especially on more commoditised issues, but many lawyers remain confident. In-house lawyers tell of external lawyers refusing to reduce fees, but instead offering to help legal departments to prioritise better their workloads.

Those firms that do lower their fees may regret doing so in the long-term, believe some. “We are not going to play the fees game. The market will return in a year or two and we don’t want to be in the position of having to try to recover our position,” says the managing partner of one Madrid-based City firm.

Even so, a prolonged downturn may take its toll. And some say that it will be felt particularly among smaller corporate-led firms that have capitalised on the boom in M&A and private equity deals in recent years.

One managing partner added: “There is some ability in Spain to keep M&A lawyers busy with corporate aspects of restructuring and litigation, but the magic ingredient is a good finance and tax practice which some firms lack. Those without it may find that if matters don’t improve over the next year then remaining independent may prove increasingly difficult.”

Reinvention

The scale of the issues potentially facing law firms means however that some will inevitably have to reassess their size and market focus. The likely outcome for some of the London firms currently in Madrid, some suggest, could be smaller less specialist offices.

That said, many at the London firms emphasise that, unlike within their City headquarters, there has never been the drive towards super-specialism in Madrid, and so there are unlikely to be large scale redundancies even in the hardest hit practice areas.

Some do though accept that they may have to change their ratios, albeit at the top end. “An issue for us is our number of partners. It is much more cost-effective for us to have the same number of associates as we currently have to revisit the number of partners,” says one Madrid managing partner.

A change of style is already evident among some of Spain’s largest firms. Cuatrecasas recently concluded a management board reshuffle and change of focus that saw the departure of some of its senior figureheads, leading to a stronger presence by the firm’s Madrid-based partners.

In any event, short-term fixes may prove to be irrelevant, suggests Steve Blundell, consultant at London-based Gracechurch. “Law firms need to be adaptive but as they have no retained earnings they are less inclined to take risks. This leads them to look at their financial engineering – for example, partner remuneration – whereas other businesses would simply adapt working patterns and tasks until the work levels returned.”

One clear advantage for the UK firms is still their global networks with which they can clearly demonstrate their ability to assist Iberian clients to expand internationally. In addition, it also offers increased mobility for their lawyers and the ability to re-orientate themselves towards new or expanding markets, say some.

In September, Allen & Overy announced the launch of an office in São Paulo, its first in Latin America, and where both Clifford Chance and Linklaters have also expanded recently. A large number of City law firms – and a growing number of US firms – are also expanding across the Middle East and Asia, in their pursuit of sovereign wealth fund clients.

“Our model dictates that we have to continue to follow the money. We have to continue to demonstrate our expertise and to assist clients invest wherever that, and they, may be,” says a Madrid managing partner at a magic circle firm.

In any event, say some, law firms will be busy over the coming months restructuring many of the M&A deals that their corporate departments have spent the last few years creating.

“A legacy of the complex, highly-leveraged deals that so occupied us over the last few years is that they will demand equally specialist finance, corporate and tax advice to keep them from collapsing,” says one Madrid partner.

Likewise, say some, the severity of companies’ legal issues means that there is even greater emphasis on “quality” legal expertise. “Cost is currently not an issue. Clients want gold or even platinum-plated advice and are not going to argue over an additional €30,000.”

Eventually the markets will inevitably return, says one Madrid partner. The strongest, most balanced and best-managed firms will continue to do well and come out at the other end even stronger.

“Despite the news we are seeing from London and New York it is not in our character to get too stressed about what may or may not happen. We are tempted to say ‘no pasa nada’, stick our heads in the sand and, for the moment, simply return to the still significant profit levels we had in 2005.”

Clients are in any event already now looking for their lawyers to act more as business advisers, suggest some. They want deals to be done, restructurings to be concluded as well as receive help in spotting new or emerging opportunities. The firms that can provide these kinds of service, they suggest, will be those that most quickly work themselves out of the downturn.