Northern Ireland has seen its economic prospects transformed since the end of the Troubles, but the credit crunch threatens to undermine its growth. So, asks Derek Bedlow, a decade after the Good Friday Agreement was signed, is the province facing a dip in the peace dividend?

The last time Legal Week focused on Northern Ireland, it found an economy and a legal market in rude health – deals were plentiful, property values were still exploding and the return of the devolved government to Northern Ireland promised a new era of inward investment from both the private and public sectors. All its law firms had enjoyed a record-breaking year and were expecting the same again.

Wind forward 12 months, and the picture – both globally and locally – has changed somewhat. While most of Northern Ireland's firms did enjoy a very good year, much of this was down to the UK's ending of taper relief for capital gains tax, which presaged a spate of business owners divesting assets before this generous break was removed.

Looking forward a further 12 months and the future looks less assured, with last year's unbridled optimism turning cautious, if not yet outrightly pessimistic, as the credit crunch makes itself felt in Northern Ireland.

Property in particular is a concern. Northern Ireland has enjoyed an 800% rise in house prices in the past 15 years, albeit from a low base, but this has now gone into reverse. It remains early days, but the downturn in the -residential market is spreading to parts of the -commercial property market; some banks have stopped lending on -property and those that are still lending are taking a much more rigorous approach.

Law firms are developing their insolvency, business recovery and litigation teams in anticipation. "A lot of the frothy activity over the past five years has been property-driven and a number of business owners invested into property as a sideline," says Richard Gray, a partner at L'Estrange and Brett.

"Although it is a bit early to tell whether that means that a property downturn will have an impact on the economy here, we see difficult times ahead for a number of businesses, particularly property developers, and we are gearing up our corporate recovery practice accordingly."

Yet, while Northern Ireland is far from immune to the economic trends affecting the UK and the Republic of Ireland, there are a number of factors unique to the region that may serve to insulate it from the worst effects of the credit crunch.

The first of these are the potential economic benefits to come from the return of devolved government to Northern Ireland last year. The focus of the devolved government, and its inward investment agency Invest Northern Ireland, is to move the province's economy further up the value chain, moving away from call centres and trying to attract industries such as high-tech manufacturing, biotech, IT, renewable energy and financial services – an endeavour which Northern Ireland's lawyers hope will be assisted by the greater political stability they hope that the devolved government can provide.

"The return of power sharing has improved Northern Ireland's ability to sell itself to foreign investors," says Brendan Fox, a partner at Cleaver Fulton Rankin.

One of the Northern Ireland Government's first major initiatives since the return of power sharing was to organise the US:NI conference, which was aimed at attracting investment from the US. The event, which took place at the beginning of May, attracted 100 executives from US companies as well as heavyweight politicians from both sides of the Atlantic. A number of new investments were announced, by companies such as aerospace firm Bombardier and NYSE Euronext.

More practically, the country's lawyers also hope that the devolved government will reform the notoriously slow planning system in Northern Ireland, which has had the effect of diverting some development investment towards other parts of the UK and Ireland.

"We all hope that an uplift provided by the return of the devolved administration focused on the local economy and increased US investment will, to some extent, counterbalance world trends," says L'Estrange's Gray. "It is beginning to come through now, but it will take some time to bear real fruit."

Closer to home, another source of investment that some hope could sustain Northern Ireland through the worst of the downturn is the Republic of Ireland. Since the Good Friday agreement in 1998 set up a number of cross-border bodies (including one for trade and business development), the degree of integration and co-operation between the economies of Northern Ireland and the Republic has continued apace.

Last year saw the creation of an all-Ireland electricity market and business and investment has been flowing freely both ways, especially in the construction, property, energy and banking fields. "There is probably some residual political resistance to further economic integration, but there is no question that the fences are down in a number of key areas, especially in infrastructure," says Gray. "Both sides of the political spectrum seem to have accepted that some degree of co-operation is essential for economic development and that without a successful economy, they cannot achieve anything else. The creation of the single electricity market is proof of that – it would have been anathema to Unionists 30, 20 or even 10 years ago."

However, politics has interfered with the progress of another initiative that could have provided a further boost to cross-border cooperation, and indeed, pan-island inward investment. Last year, the former head of the Inland Revenue, Sir David Varney, was commissioned by the UK Treasury to conduct a review of tax policy in Northern Ireland. One proposal he was asked to evaluate was whether to reduce corporation tax in Northern Ireland from the UK rate of 28% to the Republic of Ireland's rate of 12.5%. The proposal had the support of both the Democratic Unionist Party and Sinn Fein but, earlier this year, Varney came out against the idea, citing the difficulty of introducing differing rates to other devolved parts of the UK.

For most lawyers in Northern Ireland, the outcome was disappointing but not surprising. "Nobody was especially surprised by the outcome and we did not factor it into our planning," says Alan Bissett, a partner at Carson McDowell. "We are optimistic that there will still be a lot of inward investment into Northern Ireland, particularly in light of the recent successful investment conference hosted by Invest NI. So while tax equalisation would have been a bonus, it should not stop investment from coming in."

A deal that is causing a little more excitement was the arrangement in April between the finance ministers of the North and the Republic to encourage banks and financial services companies which have taken advantage of the fiscal regime in the Republic to set up back office operations in Northern Ireland. The Republic's rules require that banks and other companies must have a minimum level of operations in Ireland to benefit from its low tax rates, and the Republic has agreed to include operations based in Northern Ireland to count towards this minimum.

"The Celtic Tiger has been roaring for a long time now and there is a resourcing issue in the Republic," says Mark Thompson, partner at A&L Goodbody's Belfast office. "Northern Ireland has a surfeit of well-educated people, so there is an obvious opportunity there."

The then Northern Ireland finance minister, Peter Robinson, claimed that the deal could create thousands of high-value jobs in the North while alleviating some of the staff shortages being experienced in the Republic. Bank of Ireland has already established a derivatives operation in Belfast and rumours abound that ABN Amro and Merrill Lynch will join them, and last year Citi established a significant back office function in Belfast, which included a legal department. However, there remains some caution among lawyers that financial services will create a bonanza, not least because the credit crunch has dented the prospects of the financial services industry in the Republic of Ireland. "If the financial sector does move in, then it will be in quite a limited way in the next few years," says Fox.

For these reasons, some lawyers consider that the North cannot rely on all-Ireland economic development to provide for all of its economic future. "Northern Ireland cannot rely solely on outsourcing or back office jobs from the Republic," says L'Estrange's Gray. "We need to create sustainable industries and businesses here. Outsourcing jobs in the financial services and other sectors is an element of the economy, but it cannot be the only element."

While everyone waits for the full benefits of inward investment to be realised, the more immediate benefit to the economy, and Northern Ireland's lawyers, is the level of public spending it has enabled to go ahead. Almost £20bn of public money – from the UK Government, The European Union and the Irish Government (which has pledged £700m) – will be invested in Northern Ireland's infrastructure over the next 10 years, aimed, in particular, at upgrading its roads, tourism facilities and to regenerate neighbourhoods. "The Northern Ireland Government has some ambitious plans and the public sector is investing significant sums of money," says Carson McDowell's Bissett.

The extent to which this will cushion the blow being delivered by the credit crunch is the matter of some debate, however. "We are insulated against wider economic trends by public sector investment, but we cannot be naive about it," says Tughans partner Ian Coulter.

Indeed, many of the new projects will be funded on public finance initiative (PFI) or public-private partnership (PPP) principles and if Northern Ireland firms are to take advantage of the public sector boom, they will need to raise their profiles higher on these projects than they have generally managed (with some exceptions) to date. While domestic firms have enjoyed some success in persuading banks and private sector members of consortia to appoint them, they have struggled to persuade the public sector, which has frequently used firms from England, Scotland and the Republic of Ireland, to do the same.

More recently, Northern Ireland firms have begun to fight back by hiring specialist lawyers from British and Irish firms, joint venturing with outside firms to gain experience and lobbying (via the Northern Ireland Law Society) the devolved Government to keep a greater proportion of its legal fees within the jurisdiction. The perception that local firms lack the right experience, still held by some civil servants, is unfair, they say.

"We started off working for the banks in PFI, but we have grown that role to include contractors," says Bissett. "The fact that we are receiving these instructions demonstrates our ability to this work. Public sector projects should be going to Northern Ireland firms now that we have the specialisms in place."

In commercial areas, domestic firms have been making clear strides to win mandates that in the past would have gone to firms from the mainland, helped in no small measure by the number of experienced Northern Irish lawyers they have persuaded to return from commercial firms in London, Dublin and elsewhere.

"We have developed exponentially as a firm in the past five years," says Tughans' Coulter. "We have a large number of people who have come back from London and Dublin firms and they say that the work is as challenging here as it was at their previous firms."

Gray adds: "There is no question that the sophistication of commercial legal work has gone up considerably in Northern Ireland.

"The size of deals has also increased – we have already completed four M&A deals this year in excess of the £100m mark, which is unprecedented in our experience in Northern Ireland and a real sign of its growing prosperity."

With growing sophistication comes greater demand on law firms to deliver greater specialisation and scale, yet the majority of work still comes from small to medium enterprises (SMEs). Law firms have to manage a two-track market – having the expertise and size to handle the occasional large deal while maintaining a cost base that is affordable to SME clients.

These trends have convinced the newest firm in Belfast, Goodbody's, that the wind is blowing in its favour. Being an all-Ireland firm, it says, enables it to win referrals from London firms, while its experience in projects south of the border puts it in a strong position to win work in the north.

"The arrival of Citi is part of a general movement of the economy to become more sophisticated and the law firms are having to make sure their legal services are of a similar standard to what clients expect in London and Dublin," says Goodbody's partner Peter Stafford.

"You need to have scale in order to provide the specialist services that the market requires. As the market matures, it will be increasingly difficult for local firms to stretch themselves between SME work and more sophisticated work and the gap between tier one firms and tier two will grow."

Yet while most of the leading firms acknowledge that becoming part of all-Ireland firms in the long run may be inevitable, they are in no hurry to join them just yet, not least because they do not perceive the two that have already set up shop in Belfast – Arthur Cox, which has been in Belfast since 1996, and A&L Goodbody, which opened in Northern Ireland last year – to be offering a significant threat to their market share.

"Dublin firms have invested a lot of money in developing a presence in Northern Ireland that can compete with the large domestic firms," says one lawyer. "They have done this on the assumption that devolution will produce an economic bonanza in which they can share, but it will be two or three years until it becomes apparent whether they will see a return on their investment or not."

One effect Dublin firms have had, however, is on salaries, which went up by 30% in some areas last year. If there is a downturn, some firms could find themselves exposed. Yet, no matter how deep the downturn, lawyers in Northern Ireland will always have a slightly different perspective to those in other jurisdictions. Regardless of how hard times become, they will be nothing compared to what came before. "When I compare how things were in the 1980s, when there was a high level of sectarian violence and the economy was unstable, I still have to pinch myself to believe how good things are now," says Cleaver Fulton Rankin's Fox.

NIJune2008