.TROUBLE AT THE TOP: Is the magic circle losing its clients?

For years, national UK firms have predicted that the magic circle’s domination of European law is coming to an end. National firms, they argued, would encroach on the elite firms’ practices as clients grew more sophisticated and more concerned with value.

Now, it seems, that shift might be beginning. Chambers’ sixth annual Euro Survey shows that European public companies are indeed turning from the magic circle in favour of cheaper firms. In this year’s results, for the first time, all of the magic circle firms and several ‘white shoe’ US firms have fewer mentions than last year.

Fewer mentions for the elite

Linklaters falls the furthest, shedding six mentions since last year. Clifford Chance has lost four mentions, Allen & Overy three, Freshfields two and Slaughter and May one.

The magic circle

By contrast, ‘chasing pack’ and mid-tier UK firms have performed well. Herbert Smith, Norton Rose, Denton Wilde Sapte, Simmons & Simmons and Ashurst all gain one mention, as do national firms Eversheds and DLA Piper.

The 'chasing pack' and UK national firms

The same pattern can be seen with US firms: the elite ‘white shoe’ firms such as Shearman & Sterling and Cleary Gottlieb see reduced mentions this year, while Baker & McKenzie has seen an increase.

The top US firms

Smaller firms were quick to pounce on the results as evidence a fundamental shift is taking place, accelerated by the recession. “In every sector of the market, fee pressure is as intense as I’ve ever known it,” says Andrew Darwin, managing director for Europe at DLA Piper. “General counsel aren’t going to keep spending 25% more than they need to for magic circle firms, just for old times’ sake.”

Fewer mentions for the ‘global elite’

A further analysis of the results demonstrates just how worrying the signs for top-tier UK firms are. Last year, 63% of the Euro 100 clients mentioned two or more of the ‘UK global elite’ (Allen & Overy, Clifford Chance, Freshfields and Linklaters). This year, the percentage is only 34%.

The magic circle firms point out that the last few years have seen fewer of the kinds of transactions and projects that clients typically use them for. “With fewer major deals around, some clients have not had enough major work to employ two or three top-tier firms and are just using one,” says Konstantin Mettenheimer, co-senior partner of Freshfields.

The figures bear that out: last year 17% of clients mentioned just one global elite firm; this year that rises to 37%.

But there has also been an increase in the number of firms who do not mention an elite firm at all: from 20% last year to 28% this year. Of the nine new clients in this year’s survey, five name no magic circle firms at all.

Use of 'UK global elite' firms by Euro 100 clients

It’s striking that not only national firms, but also smaller City firms such as Norton Rose, have seen increased mentions. Some have predicted these firms would be caught in the middle, priced out of lower-value work by the nationals but unable to attract big transactional mandates. These figures suggest that, in fact, clients are comfortable giving more work to these firms.

Norton Rose Group CEO Peter Martyr says this is because of smaller firms’ greater focus on client relationships. “The magic circle have great relationships with investment banks across the board, but we focus instead on deep relationships with the leading companies and banks in our key business sectors,” he says.

The findings are in line with other recent research. In 2008, Eversheds released a report called Law Firm of the 21st Century, stating that 34% of FTSE 250 clients intended to buy less work from the magic circle in future. And, last year, Chambers Client Report interviewed several FTSE 100 and 250 general counsel, all of whom said that they expected to obtain better value for their work – and several of whom said that they had found the magic circle most resistant to their efforts. (See feature, “Tougher Than Ever,” Client Report 27.)

A nervous future

Magic circle partners accept, at least up to a point, that clients’ increasing focus on value poses a challenge to them. “We see a trend developing where for mid-market transactions of around €300 million, clients are increasingly likely to look into LPO formulas or engage smaller domestic or boutique firms, or mid-tier international firms,” admits Jean-Pierre Blumberg, European managing partner of Linklaters.

Elite firms are confident that major, ‘bet the company’ transactions will still be theirs for the taking. “We still find that when the going gets really tough, clients consistently come knocking at our door,” says Freshfields co-senior partner Konstantin Mettenheimer.

“With so much uncertainty in the markets and fluidity in terms of the legislative agenda, clients want the security that comes from working with the very best advisers,” argues David Childs, managing partner of Clifford Chance.

But, they admit, the number of major transactions won’t return to pre-crisis levels for some years. “If you look at the underlying trends, it’s clear that we’re entering a period where there will be fewer mega-transactions,” says Jean-Pierre Blumberg.

And the kinds of high-value work generated by the recession, like restructuring and regulatory advice, don’t support the high levels of leverage that the magic circle grew rich on. “There are a lot of partners walking around wide-eyed, trying to figure out how to maintain their practices,” admits one German magic circle partner.

New habits

The threat to the magic circle shouldn’t be overstated. During the boom, these firms were overloaded with work, leading to hand-wringing about overworked associates and concerted attempts to reduce attrition. “We could have grown to 8,000 lawyers on the work that was being offered us,” says one magic circle partner.

In those circumstances, the elite firms were often quite happy to hand off smaller transactions to other firms. Now, though, the magic circle needs that work to offset the decline in big transactions. But it is finding that work going to smaller firms.

To stay busy, magic circle firms are having to learn new habits. Magic circle partners deny neglecting their relationships with corporates during the boom. But they admit that in future they will have to invest more in relationships and be more flexible.

“I don’t think we’ll change our basic strategy of aiming at the top end of the market, but we will become more sophisticated in our approach,” says Jean-Pierre Blumberg. “We will focus more on relationships rather than deals. For the most important relationships, that will mean broadening the scope of the work we’re willing to do and being more flexible on pricing.”

Already the law firm most associated with the investment banks, Clifford Chance, is taking steps “to broaden and deepen our ties to leading organisations across a wider range of sectors,” according to David Childs.

Of course, most magic circle firms – having carried out extensive restructuring during the recession – have fewer ‘mouths to feed.’ But many worry that the ructions in the market may mean the cuts are not over. “I suspect that partnerships at the biggest firms, particularly in continental Europe, will need to shrink substantially over the next few years,” says a German magic circle partner.

(For more on the future shape and size of the magic circle, see our feature “The New Model Law Firm,” Client Report 28.)

Eventually, boom times will return, and the magic circle may again have the luxury of turning away work. But the shift of the last two years may well be permanent, with more and more work of considerable value going to non-magic circle firms.