Editors' Blog

Links and Freshfields brands rising in US: AmLaw on the magic circle

Posted 28/09/2007 by Richard Lloyd

In June, shortly before becoming Prime Minister, Gordon Brown announced, "[This is] an era that history will record as the beginning of a new golden age for the City of London." Meanwhile, New York was digesting the findings of a McKinsey report, commissioned by Mayor Michael Bloomberg, on how the Big Apple might respond to London's resurgence as a financial center.

More and more, investment bankers, hedge fund specialists and private equity dealmakers are being drawn to the city of sky-high rents, creaking infrastructure and over-priced beer. M&A across Europe has soared - in 2006 more deals were done on the Continent than in North America, according to data from mergermarket - and more typically than not, the financing for these deals is raised in London. Fleeing Sarbanes-Oxley, international companies are increasingly looking to list on Europe's equities markets. Last year, more money was raised by companies on AIM than on America's Nasdaq.

These new market dynamics have played into the hands of the magic circle quintet that dominate high-end corporate work in London and most of Europe's major jurisdictions. In the last financial year, the five magic circle firms all reported growth in profits per equity partner (PEP) of more than 20%. In the process, they have dispelled some views of the UK market held stateside - Brits are soft on underperforming lawyers, are blindly wedded to inflexible locksteps and take too many holidays. As a group, the magic circle is gaining ground and in some cases surpassing their US rivals.

In the October issue of Legal Week’s US sister title The American Lawyer, we are paying special attention to two magic circle firms, longtime rivals Linklaters and Freshfields Bruckhaus Deringer. This year Linklaters' soaring profits have put it among the 10 most profitable firms in the world. Slaughter and May still has the magic circle's highest PEP but most of its lawyers remain based in London. Linklaters has defied predictions that a firm could not grow a global practice of breadth and depth and still be as profitable as all but the richest New York firms. Under the guidance of managing partner Tony Angel, Linklaters has left its UK competitors playing catch-up - especially Freshfields. Both have undergone significant change in recent years, transforming into integrated global businesses. But they have done so under starkly different management styles.

American Lawyer looked at the magic circle as a group, comparing their financial performances since 2000 with those of their US competitors and some UK rivals. We chose two comparison groups of US firms: one comprising the 10 most profitable New York-based practices, from Wachtell Lipton Rosen & Katz to Cleary Gottlieb Steen & Hamilton, and a second group made up of the 10 US firms with the most lawyers based overseas, including White & Case and Latham & Watkins - although not Baker & McKenzie, whose global model remains unique.

These are not perfect comparisons. With the exception of Slaughters, the magic circle have globalised far more than their US counterparts - Freshfields, for example, has 68% of its attorneys outside of the UK, compared with 16% for Skadden. (Only White & Case, with 63% of its attorneys outside the US, has the same kind of international exposure.) So Wachtell's New York-centric business model is far removed from the multi-jurisdictional approach of Linklaters or Freshfields. However, we wanted to assess how London's most profitable practices compare with their New York counterparts and with those US firms that have most closely followed them down the global path.

The most striking finding is how much, in terms of profits per partner, the magic circle has pulled away from the US global firms and narrowed the gap with New York's elite. “Some of the magic circle firms have made some almost astonishing leaps in the last few years,” says Milbank Tweed Hadley & McCloy chairman Mel Immergut.

The resurgence of the Brits since 2004 owes much to Europe's buoyant markets and the rise of China. Of the magic circle firms, none but Clifford Chance (CC) has a significant presence in the US - but that didn't seem to matter over the past year. The investments that Linklaters, Freshfields, CC and Allen & Overy made in opening overseas offices during the past two decades have paid off, giving them first crack at the biggest corporate deals outside America.

In addition, the UK leaders have taken better control of their global costs, introducing tighter management of their back-office functions and starting to explore savings from outsourcing support services. A few years ago, CC had more support staff than attorneys - now it has just over 3,000 non-legal staff compared with more than 3,500 fee earners.

The British firms have also reined in equity partnerships. In the most dramatic illustration of this, Freshfields slashed its equity partner numbers from a high of 526 in May 2004 to around 420 today and became the last magic circle practice to introduce non-equity partners to its ranks.

For the magic circle firms, the average revenue per lawyer (RPL) figure has improved, but still lags far behind the New York elite and has only just passed the average for the most global US firms. On this figure, however, all the US practices benefit from having the majority of their lawyers in America, where hourly charge-out rates tend to be higher than in most markets in Europe and Asia.

The weakness of the dollar has also helped the performance of UK firms relative to their US competitors, points out law consultant Partha Bose - who in 2005 predicted the magic circle's prospects would ultimately decline. Earlier this year the US-UK exchange rate hit $2 to the pound for the first time since the early 1990s.

“A lot of the magic circle firms' increase in profitability and new growth has to do with Gordon Brown," claims Bose, referring to the rise in the value of sterling during Brown's tenure as chancellor of the exchequer. “The big jump in profits has been driven by the pound.”

However, for our research, we used the average exchange rate from calendar year 2006 - $1.8434 to the pound - which tends to minimise the impact of the pound's 2007 surge.

What's more, the magic circle is easily outstripping its cross-town rivals, who also tally their finances in pounds. Five London-based firms that rank just below the magic circle in reputation and profitability - Ashurst, Herbert Smith, Lovells, Norton Rose and Simmons & Simmons - all have established international networks, though typically not as extensive as those of the four global magic circle firms. Yet the gap between the very top of the UK market and the second tier is growing, as measured by both RPL and PPP. Of these second five firms, only Ashurst and Herbert Smith, with PEP of $1.76m and $1.51m, respectively, have profitability levels approaching magic circle levels.

“We think there's a top seven in the UK market and that we're distancing ourselves from the rest,” insists Ashurst senior partner Geoffrey Green.

How the UK elite weathers any downturn in Europe and Asia will be the true test of the Brits' resurgence. As American partners like to point out, the magic circle cannot rely on litigation to make up for a decline in corporate or finance.

“Even though they are leaner and meaner than in the past, they don't have the support of a large litigation practice,” Milbank's Immergut says. “But there would have to be a global recession to really impact the magic circle firms."

rlloyd@alm.com