Inside this special report
* Winds of change
* Foreign firms face rocky road in Tokyo
* The sun rises again
Winds of change
The ongoing Nishimura & Partners and Asahi Koma Law Offices combination is a symptom of the pressures being faced by local firms in a changing legal market. Japanese firms are coping with an era of mounting demand for quality legal services, combined with an anticipated injection of rapidly growing numbers of law school-qualified Japanese bengoshi and the growing hunger of circling foreign law firms vying for an increased portion of the awakening local client base. Law firms like Nishimura & Partners are looking for ways to keep ahead in this time of change.
A necessary evil
Prior to the 16-year-long slump of the Japanese economy that began in 1990, there was little call for the involvement of law firms in the business transactions of Japanese companies. With government bureaucrats heavily involved in economic development and business decision-making, and little in the way of litigation, lawyers were, according to Toru Ishiguro of Mori Hamada & Matsumoto, an "unnecessary evil".
How times have changed. In the 'lost decade' of the 1990s, law firms suddenly faced a different world, where businesses made their own decisions in an increasingly litigious society, forcing even the most conservative industries to become more aggressive. As a result, law firms are now playing a vastly bigger part in the domestic economy, as businesses realise the need for advice. Nagashima Ohno & Tsunematsu chairman Hisashi Hara estimates in the 1980s, 80% of legal work was garnered from cross-border transactions. Compare that to the current market, where Hara says 70% of work is purely domestic.
This trend has only been magnified by the continued resurgence of the Japanese economy, now into its sixth year, which has encouraged increased amounts of inbound, and more recently, outbound investments. The business sector has also undergone a sweeping series of regulatory changes over the last few years.
The changes have pushed legal service demand to an all-time high. Whether it is advising on the inbound investment of a global private equity firm, the outbound expansion of a domestic business reveling in its new-found prosperity, or advising a local corporate on the ramifications of the new Company Law, lawyers have become a "necessary evil".
School's out
Many firms are tipping the growing number of locally qualified bengoshi graduating under the newly-minted US-style law school system to put the biggest pressure on local firms in the near future. In fact, they rate this much higher than any impact foreign firms are making. Under the system, the number of Japanese attorneys is expected to double over the next 10 years. This year, 1,500 new lawyers were admitted to the bar, with 3,000 expected next year, and figures as high as 5,000 are suggested for years to come.
The decision to increase numbers through the new system was made due to the aforementioned legal demand, and the large deficit between this demand and the numbers the current market can muster. However, feedback from the market is there will likely be too many lawyers flooding the market. "There's a very healthy market right now, and everybody is experiencing rapid growth," Nishimura & Partners' Bohrer says, "but as for the increased number of graduating lawyers expected to hit the market each year, it has many people scratching their heads as to how they will all find jobs."
The impression of the law society was that many companies would hire lawyers from law school into in-house roles, but Bohrer says this has not proven to be the case so far. He says companies are looking for experienced attorneys, not fresh faces from law school. It may be that more will find jobs in country areas, where there is a dearth of lawyers, or in one of the foreign firms in the market, as many seek to expand their local law capabilities.
The situation will likely mean law schools will feel the heat. For law firms, it means decisions have to be made on how to manage the influx of younger lawyers. For Nishimura & Partners, which has obviously taken a more aggressive growth stance as shown by the Asahi Koma merger, it will mean vastly expanding its number of new recruits. Bohrer says the firm intends to recruit in the vicinity of 70-80 lawyers this year, which is a massive shake-up for a firm that took on 29 new graduates last year.
Such large increases in numbers will change the culture of Japanese firms that take a similar approach to Nishimura. Previously, good young lawyers in Japan were virtually guaranteed a partnership track, but with firms such as Nishimura taking on up to 80 new graduates, the end result of a usual 10-year partnership track will not be a firm with 80 new partners. Bohrer says firms will have to adopt models similar to other jurisdictions. Lawyers will also likely move toward specialisation in niche areas.
However, not all firms are opting for a rapid upsizing. Mori Hamada & Matsumoto has chosen a more conservative approach in order to ensure quality is maintained. "For us, it would be impossible to match the pace of the increase expected to be taken by some of the other large firms at the same time as keeping up the quality of our advice and training we offer our newly graduated lawyers," says Ishiguro. "Our pace of growth will not be slow compared to the last 10 years, but it will appear slower than other firms. In several years, it may be we have a number of lawyers that is even 100 less than some other firms."
Ishiguro says the firm aims to hit the right balance, but each path taken by firms will offer different challenges, either through coping with a rapid addition in numbers and internal changes or potentially losing some competitive advantage in terms of pure critical mass.
Mid-sized Osaka-based Oh-Ebashi LPC & Partners will also take a more conservative growth stance, as will some smaller firms, like Matsuo & Kosugi.
Competition and conflict
Since 2000, there has been a wave of mergers and consolidation among local Japanese law firms who have sought critical mass to maintain their competitive advantage over each other and the threat of incoming foreign firms. It started with Nagashima Ohno's merger with Tsunematsu Yanase & Sekine back in 2000, creating the first ever domestic firm with over 100 lawyers, and followed with others involving the present big four, such as Anderson Mori's combination with Tomotsune & Kimura, and Mori Sogo's merger with Hamada & Matsumoto. The result, when including the latest merger of Asahi Koma & Nishimura & Partners, is a legal landscape with drastically reduced choice for clients.
While sophisticated clients would agree that top Japanese firms provide advice that is of superb quality and comparable to that of the global firms, the growing size and sophistication of the transactions they are undertaking, such as large M&A deals, is increasingly seeing conflict of interest issues surface as a growing area of concern.
"When a mega deal comes out, several law firms will be needed to provide legal services, when you include the seller and the buyer, multiple prospective buyers in a bidding process, and the need to retain counsel to provide financing," says Masanori Sato of Mori Hamada & Matsumoto. "We often hear from clients that the number of law firms to which they think they can give these type of instructions seem to be limited, and they wish there were more to choose from," he says.
So how are firms handling the problem? Conflict of interest rules in Japan take into account the severe shortage of firms, and as long as the firm is organised as a partnership the rules look to the particular individual lawyer, rather than the firm, and it is often not a technical violation of rules for one firm to be involved with two different parties.
"If there's an adequate information barrier between attorney teams representing different buyers, it isn't necessarily a violation of Japanese ethical rules, if the firm is organised as a partnership," Bohrer says. However, there is a difference between the actual rules in place and the expectations of clients. At Nishimura & Partners, Bohrer says the firm will often clear apparent conflicts of interest (even though they are technically not breaches) by the clients involved, and strive to create a mutually acceptable solution. "Most clients understand the difficulty in retaining quality lawyers in Japan, leading to arrangements that wouldn't be imagined in some other jurisdictions," he says.
Lawyers believe the situation could provide more opportunity for smaller firms. "There seems to be room for other firms other than the big four or five to get instructions, though in reality that isn't consistent with what has been happening," Sato says.
One such up-and-coming firm is Atsumi & Partners. Partner Bonnie Dixon says the current market is positive for quality independent firms. "With mega mergers happening, clients are being freed up, and many are floating to firms like ours. We will grow in part because of market forces, as clients will have no place else to go," Dixon says.
In-house insight:
Trading questions for answers at Merrill Lynch |
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As derivatives counsel for Merrill Lynch in Tokyo, Alfred Chan is no stranger to being dealt legal questions that push the conceptual boundaries of the law, not to mention the legislative framework that has been put in place to regulate the derivatives space.
"We've been doing weather and oil financial derivatives since last year, and have just closed our first physically settled electricity transaction in Japan under JEPX [Japan Electric Power Exchange] and expect to see at least a few more this year," Chan explains. "Next we'll be looking at emission trading."
Dealing with such cutting edge financial products requires creative thinking, and regulators are often still playing catch-up. "The novelty of these products can sometimes be a strain on existing legal principles or even a bit of an epistemological exercise," Chan says. "For example, is it correct to talk about 'physically' settled electricity transaction?
"Also, 'emission' still doesn't have an agreed legal characterisation in Japan and the EU. This uncertainty goes to fundamental issues such as how to create and perfect valid and enforceable security interests and whether the trading of the same falls within the permitted banking activities under, for example, Japanese banking law."
Chan is part of a team of legal counsel that makes up Merrill Lynch's Office of General Counsel in Tokyo, which is divided into practice areas including derivatives, corporate, origination, equity, debt and principal investment. In some cross-product transactions, the heads of departments work together to give the best expertise to the business side.
Aside from new products, other challenges Chan faces as derivatives counsel are internal. One of the key tasks, he says, is building relationships and trust with the key business group heads. "It's important for the team to understand better the business groups' needs and to continue to find ways to provide them with better services," Chan explains.
The external law firms the business units engage fall mostly into the 'global local' category, according to Chan, though the firm does also engage one or two of the large Japanese firms on occasion. He says he looks for professionalism and expertise in outside counsel, with "dull, dependable stolidity" being an advantage in trying situations.
Chan says companies operating in Japan will benefit from changes in the legal market that are seeing more lawyers graduate from law schools each year. "More Japanese qualified lawyers are available and willing to go in-house which should be a good thing for employers in terms of choice and quality," Chan says. But he predicts a challenging road for these would-be in-house lawyers. "I guess the demand for quality has increased a lot and there's definitely a move towards specialisation. The 'Japan skills' can also be important in addition to their international transaction expertise," he says.
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| Asahi Koma fragments as Nishimura merger finalises |
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When the second largest Japanese law firm, Nishimura & Partners, announced it was in pre-merger discussions with fifth largest local firm Asahi Koma Law Offices, the hype in the Japanese market, particularly among partners of the other big four firms, was about the formation of a new mega-firm that would easily trounce its competitors in pure numbers.
On paper, the numbers looked imposing. At the time it was announced in mid-2006, the combination would have given the newly-merged entity more than 80 partners and almost 350 attorneys in total. This would have put it ahead of its nearest competitor at the time - Mori Hamada & Matsumoto, which had 65 partners and 225 fee-earners in total.
Almost a year later, the merger is still a hot topic in legal circles, but for different reasons. While it is going ahead, the current picture looks more like a dissolution of Asahi Koma Law Offices than a pure two-into-one merger with Nishimura & Partners. At the beginning of April, sources in the market estimated that only about 50% of Asahi Koma's lawyers would end up with Nishimura. The remainder will fracture, with some intending to remain independent, and other groups deciding to move to other firms.
At the time it was announced, ALB flagged the merger discussions were in fact between a small number of lawyers at Asahi Koma, with Anderson Mori & Tomotsune partner Tatsu Katayama telling ALB he expected hiring opportunities to result from lawyers unhappy with the plans. The predictions proved true. Nagashima Ohno & Tsunematsu has picked up one such splinter group, with 10 lawyers having agreed to join the firm.
Stephen Bohrer from Nishimura & Partners said: "We're very enthusiastic about the integration of Asahi Koma, but as is the case with any transaction of this type, there's bound to be leakage." Bohrer could not comment on the specific numbers that were joining the firm, with an announcement planned for later in the year.
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Foreign firms face rocky road in Tokyo
Magic Circle firm Allen & Overy recently announced it would add local Japanese law capabilities to its practice in Tokyo with the recruitment of two local lawyers, one from Freshfields' bengoshi stable and the other from Asahi Koma Law Offices. The move sees the firm get back into the local legal game, after having moved a few years back to focus on a purely international model, providing just US and UK legal advice to clients.
In reality, it is international work that still forms the bulk of business foreign firms are garnering in Tokyo, with many finding it impossible to lure domestic clients away from the top Japanese firms, and tough to maintain profitability in the market. Only last year, casualty Cleary Gottlieb Steen & Hamilton made a quiet exit from the Tokyo market, deciding instead to focus on the potential of its China practice and new Beijing office.
The likes of Skadden, Morrison & Foerster, Paul Hastings and Linklaters are known as firms who are making solid, profitable inroads in the market. For example, Morrison & Foerster has captured the patent and IP work of local technology heavyweight Fujitsu.
The general market perception is that some other firms are struggling. The expectation after March 2005 was that the ability to have joint ventures between foreign and domestic firms would vastly change the legal landscape in Japan, allowing foreign firms with their global platforms to encroach upon the domestic client base. But the reality is different, which is in part a tribute to the quality of service Japanese firms are already providing.
"I think the reason is the technical expertise and breadth of skills required can be handled by Japanese firms, and picking up a shop of 10 or 15 lawyers won't allow foreign firms to compete with the depth of these firms," says Nishimura & Partners' Stephen Bohrer.
The first ever foreign partner of a major local Japanese firm, Bonnie Dixon, who is growing her practice with mid-sized Atsumi & Partners, says in competition for domestic deals, the firm would only ever lose out to the bigger locals - never foreign firms.
Dixon says many foreign firms have come to Tokyo and focused on capital markets, meaning they were all chasing similar deals. She says novel ideas and new structures they introduced to the market have largely become commoditised and gone domestic, leaving these foreign entrants with "a hangover" effect. Dixon says this is compounded by the difficultly of simply importing a foreign M&A practice into Tokyo.
For some foreign firms, the Japanese market has become an ego issue. Though it may not yet be the gold mine that was expected, with expensive partners not billing sustainable hours, the global partnerships of these firms will be unlikely to admit defeat, as was the case with Cleary Gottlieb, but will instead grit their teeth and stay for the long haul.
Seeking experienced bengoshi
One of the major difficulties foreign firms are facing is attracting top quality local lawyers. The expected movement of talent to the lure of a global platform and benefits of an international firm is not having the effect international firms had expected.
"The local firms are generally of very good quality, so there's no reason for lawyers to go to foreign firms for a better type of work," says Atsumi & Partners' foreign partner Daniel Hounslow. "Domestic firms are also very, very profitable, so for a lawyer successful in the Japanese system there's no reason to go to a foreign firm."
It seems that for a top quality local lawyer rolling in local clients with not many other places to go, moving to a foreign firm is more of a disadvantage, as through doing so they may lose clients due to conflict of interest issues, lose a valuable referral source, or scare clients off due to the higher billing rates of the foreign firms.
Dixon says there are also very few top foreign lawyers willing to commit to staying in Japan for any length of time, and this is also hurting the prospects of foreign firms.
A win-win partnership
The prospects of foreign lawyers who are committed to the Japanese market are looking rosy, particularly among local firms who have started to recognise their talents.
Atsumi & Partners has led the way in the local market, appointing both Bonnie Dixon and Daniel Hounslow as the first foreign partners among local firms in the market. And it may not be long until other firms follow suit. Stephen Bohrer at Nishimura & Partners says the firm has formed a cross-border transactions group under his leadership, and all the foreign lawyers who are a part of it are on a partnership track, so it is "just a matter of time" until the firm incorporates foreign talent into its partnership.
The fact that both Atsumi & Partners and Nishimura & Partners are offering foreign lawyers work on quality transactions is already a step in the right direction for the foreign contingent in Japan. Traditionally, being a foreign lawyer at a Japanese firm has not been the most coveted role, with these lawyers largely relegated to the unenviable task of proofreading English legal documents. But the days of being "glorified proofreaders" may be numbered for such lawyers as the market develops. The number of Atsumi & Partners' foreign lawyers already tops many foreign firms in Japan, and Nishimura's cross-border group is set to grow on the back of booming foreign investment.
The Japanese Diet passed the regulations lifting restrictions on foreign lawyers forging local partnerships with bengoshi back in July 2003.
The sun rises again
Law firms have recently been reaping the benefits of the continued recovery of the Japanese economy. The upturn has seen the Bank of Japan increase interest rates from zero to 0.5% over the past year, growth in GDP, a rise in previously stagnant real estate prices, and a slow-down in the insolvency and restructuring work that has characterised the economy throughout the 1990s into the new millennium.
The growing optimism of local companies has meant more internal corporate and investment activity, increased interest by foreign investors, and a rise in the growing trend for local companies to expand and make investments in overseas markets.
* M&A/private equity
Japan has been a source of renewed interest among foreign investors, demonstrated by headline deals such as Softbank's leveraged buyout of Vodafone's Japan arm for $15.5bn. Stephen Bohrer from Nishimura & Partners says many Japanese corporates, having undergone restructuring during the economic downturn, are now in a position to sell off non-core assets as they look for capital to make overseas investments, therefore providing acquisition targets for both domestic and foreign investors. However, though new regulations on triangular mergers have become effective on 1 May 2007, Bohrer says market perceptions about using securities unlisted on a Japanese stock exchange as the acquisition currency could be a hurdle, and Japanese tax legislation still needs to be promulgated as there remains various issues that could make this type of transaction unattractive from an economic point of view.
* Capital markets and real estate
Real estate issues in the form of JREITs have been the growth story of the Japanese capital market. With rises in real estate prices and changes to legislation to allow the construction of the REIT-style investment vehicle in 2000, over 40 of these trusts have since come to market. They have diversified out of traditional office assets into an array of other real estate assets over time.
* Intellectual property
With Japanese businesses increasingly looking outward toward investments in markets such as China and Southeast Asia, there has been an increasing awareness among Japanese manufacturers and technology companies of the IP problems being faced in Asia. The Ministry of Economy, Trade and Industry (METI) has recently begun an investigation of IP infringements against Japanese companies in the region, in an effort to combat illegal piracy of its products.
* Insolvency & restructuring
Having been the source of a seemingly endless stream of work after the 1990 crash, insolvency and restructuring work is drying up as businesses increasingly find themselves in the black. Specialist in the sector Takeo Kosugi says a recent meeting of the Tokyo District Court reported there was only three corporate reorganisations filed in 2006, which he says is down on numbers which would have been closer to 20 or 30 a year for the first few years after 2000.
A legislative overhaul
A key generator of advisory work has been an almost complete renovation of Japanese company-related legislation in recent years, which has seen the advent of the New Company Law, Trust Law and Financial Instruments and Exchange Law, among others.
"There hasn't been this much reform since either the Meiji era more than 150 years ago or the US occupation after the end of WWII," says Nagashima Ohno & Tsunematsu partner Hidetaka Mihara.
This is creating opportunities for Nagashima Ohno and other firms, who are dispatching talented lawyers into the service of the Ministry of Justice for periods of two to three years to help create the swathe of new laws. These lawyers are then coming back to their respective firms and acting as experts for their clients on the laws they were involved in creating. Such an expert at Nagashima Ohno & Tsunematsu is Tomohiko Iwasaki, who was involved in the engineering of the New Company Law between 2002 and 2005.