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Financial firepower means US firms are “set to topple” magic circle

The magic circle law firms are being attacked from all angles and pressure from US practices in particular means they may have to reinvent and reposition themselves, a corporate adviser has warned.

As well as struggling in the face of the financial might of US firms, Arden said the Big Four accountants and alternative legal services providers were attacking the magic circle’s “soft underbelly”.

It predicted: “Magic circle firms may need to re-invent themselves and reposition towards a mid-market position, which is all the more important given the increased success of the silver circle firms in their target markets.”

Arden is a corporate adviser with particular expertise in the legal market – having acted on law firm IPOs – that is now part of the Ince Group, along with listed law firm Ince.

A thought leadership note entitled A requiem for the magic circle? observed that Latham & Watkins had become the first US firm to top The Lawyer magazine’s UK Corporate 50 – ranking the largest corporate practices by revenue – having dislodged Linklaters.

“The growth of US firms has been the dominant trait of the London legal market for the last five years. The extent to which the market has shifted is evident not only by the rise of the likes of Latham and Kirkland & Ellis (which also more than doubled corporate revenues, pushing Linklaters to third place in the rankings), but by the fact that US firms now outnumber their UK counterparts in the Corporate 50.

“There has been a root and branch reordering of London’s corporate landscape and the American threat to the historic dominance of domestic City players – the magic circle – is very real.”

Arden said it has taken US law firms the better part of two decades to reach critical mass, but “from here, the competitive challenge is likely to snowball”.

The total revenue of the 50 largest US firms’ London offices jumped from $4.6bn in 2016 to $7.9bn in 2021, driven by their corporate practices.

While different firms had different ambitions for their practices, the “common thread” was how aggressively they have pursued growth, backed by their huge domestic market, an advantage it was “hard to overstate”, the note said.

Though Clifford Chance’s average profit per equity partner (PEP) hit the £2m mark for the first time this year, rising by 10%, as did Freshfields, increasing by 8%, this did not mean the magic circle was “in rude health”.

Arden said: “The strength of the market has lifted profits across the board. However, these PEP figures are actually a little underwhelming when compared with the top two layers of US firms. Latham’s PEP, for example, increased by 26% to $5.7m last year, which was on the back of a 20% increase in the prior year.”

Arden argued that the “fundamental issue” for the magic circle was that “there is only a limited number of firms that can reliably colonise a space in advisory work for transatlantic mega-corporations”.

In the last couple of years, the leading five UK firms have started falling out of the list of global top 20 M&A deals by value.

“Since the financial crisis it’s been increasingly difficult to sustain a top-tier practice in London without having a credible US presence. However, while US firms have been achieving significant gains in the UK, the reverse simply isn’t true to any extent in the US.”

But the single biggest issue was US firms’ ability to pay more for talent – around two-thirds of lateral hires made in Kirkland’s City office since 2015 have been poached from the magic circle.

“Momentum begets momentum, with higher revenue growth by US law firms in turn driving higher profitability, making it harder and harder for the magic circle to compete.”

Latham & Watkins saw a 40% increase in global revenues in the last two years, compared to 10% at the likes of Clifford Chance and Linklaters.

The magic circle has tried to compete with the huge pay rises for associates “but are being increasingly priced out of the market”. They could compete as wage inflation would go through the whole firm.

“The reality is that they have only maintained their high margins by cutting product areas and cutting some of their senior partners (which has in turn weighed on revenue growth), but once you have done that trick once, you can’t repeat it.”

And if you could not hire “elite people” for an elite model, “then it simply doesn’t work – ultimately you can always tell (and sell) top quality”.

The magic circle was being attacked from all angles, with the Big Four capturing “a significant share” of market in the last decade and increasingly competing with traditional firms.

“Big Four accounting firms are well placed to accelerate their share of procedural legal work for large corporates i.e., due diligence and employment. Deloitte, EY, KPMG, and PwC have used their brand recognition, global reach, technological capabilities, and huge existing client bases to rival mid-market and even top tier firms, and are now looking to seize an even larger share of the legal market.

“This is also highlighted by the rising importance of ALSPs as competitors to traditional firms, underlining the sense that real change is finally here. With the Big Four and ALSPs attacking the soft underbelly, the magic circle are being forced to focus more on the high end but are being increasingly outcompeted by the Americans.”

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