Just over a year since China's hub for piloting financial reform opened for business, Elizabeth Broomhall looks at the opportunities the Shanghai Free Trade Zone holds for international lawyers

When Shanghai was chosen as the testing ground for Chinese economic reform, it was far from surprising. A financial centre, a transport hub, a thriving tourist destination – this glittering coastal metropolis has long been the poster child for China's economic success story.

The Shanghai Free Trade Zone (SFTZ) – the first of its kind in China – was launched in September 2013 to demonstrate the country's ability to participate on the free market stage. Intended as a testing ground for economic reform, the zone is meant to attract foreign investment in a range of sectors including telecoms, logistics, e-commerce and finance as well as law. In order to do this the government promised to pilot reforms including easing currency trading restrictions and other limitations currently placed on international companies operating in China.

It is hoped that the zone, which is spread over 29 sq km in the new Pudong area, will eventually be expanded to cover the entire Pudong district, spanning a massive 1,210 sq km. During a two-day visit to the site for its one-year anniversary last month, Premier Li Keqiang was reported to have given companies registered in the zone the green light to 'push the boundaries' into surrounding areas.

But despite Li's enthusiasm, and statistics that suggest 12,000 foreign companies have registered in the zone already, many remain sceptical about whether the proposed reforms will ever materialise. For law firms especially, the lack of clarity on what the new rules will allow has left many lawyers disillusioned.

A turning point
According to the most recent government announcement, the new rules will permit Chinese and foreign law firms with representative offices in the zone to mutually dispatch lawyers to each others' offices to work as consultants, and will also allow them to set up joint operations in the area. On the surface, these rules represent a significant departure from the existing regulatory framework for lawyers in China, which currently bars foreign outfits from participating in PRC legal affairs and allows them only to open representative offices in the country.

Several firms, including Linklaters, Baker & McKenzie, Simmons & Simmons and Herbert Smith Freehills, have already started thinking about potential partner firms, and have openly expressed their interest in taking advantage of the zone. 

In May Linklaters' managing partner for Asia, Marc Harvey, said the firm was "looking very closely" at its options in the SFTZ, while Bakers' former Asia chief, Winston Zee, said in August that his firm was "talking to all sorts of people to come up with a game plan".

Others however, have questioned what a 'joint operation' actually means, and accuse the Chinese government of being slow to provide clarification. In reality it is still unknown what benefits the SFTZ will provide beyond allowing firms to jointly pitch for work, and in turn how this would boost revenues and dealflow.

"Part of the problem is that when they [the government] draft these regulations, because they're afraid of giving away too much, often it's not clear what they are giving," explains one partner at a top-tier international firm in Shanghai, noting that there have always been arrangements between PRC firms and foreign firms of various kinds, such as those between Pinsent Masons and Hesen Law Firm, and McDermott Will & Emery with MWE China Law Offices.

"What you still can't do is form a single [financially integrated] firm. Even King & Wood Mallesons (KWM) can't do that."

Exacerbating the problem is the requirement that foreign firms have representative offices in the zone itself. For many international partnerships this would mean an office relocation, since most already have bases in Shanghai's central business district. 

"If you just want to stick your toe in the water [that's not possible]," adds the partner. "You have to go all the way and move your entire operation to the FTZ. Then you have questions about whether your staff would want to travel all the way out there every day. Nobody is going to put a whole lot of money into the FTZ and open up in a big way unless it's crystal clear what they are going to be allowed to do."

In-house lawyers believe that the cryptic nature of the proposals reflects the government's desire to limit financial reforms to the zone area. It has been slow to act, they say, because it is still trying to figure out how best to do this.

"The big challenge is how to liberalise but keep it contained," says Douglas Arner, a professor from Hong Kong University and head of the Department of Law. "If you liberalise so that anyone can do anything there [in one place] then certainly what will happen is the entire financial system of the mainland will move into that FTZ, and that's not the objective at this point in time.

"So the question is very much how to isolate it from the mainland while, at the same time, open it to the outside world. At the moment that's being a very carefully balanced process which means the activities going on are quite limited. The regulatory approach and even the policy ideas are still very much evolving."

Outbound focus
Even if clear SFTZ policies do emerge, firms will need to consider whether their practices in China actually require local PRC counsel. In recent years most international firms have turned their attention away from inbound to outbound China deals, concentrating particularly on cross-border energy acquisitions and US or Hong Kong initial public offerings, none of which are dependent on PRC capability.

Likewise, since many of the most attractive clients are state-owned companies, the trend has been for firms to plough money and resources into Beijing while simultaneously reducing investment in the commercial hub of Shanghai. Last July US firm Vinson & Elkins (V&E) announced it was closing its Shanghai office, commenting that most of its clients were now in Beijing, while in December it emerged that Eversheds was to run its Shanghai base with no partners.

V&E and Eversheds are not alone in their decisions to limit their Shanghai investments. Firms such as Davis Polk & Wardwell, Simpson Thacher & Bartlett and Cleary Gottlieb Steen & Hamilton still don't have Shanghai bases, despite being among the more active US players in China. 

"My sense is that there are potential opportunities [in the SFTZ], but more for those with strong foreign direct investment and international trade focuses," says another partner at a leading UK firm. "For them it represents a good opportunity. For outbound M&A and capital markets, it's not as important."

But not everyone agrees. Bakers' Zee believes that inbound investment will continue to be important for all international law firms – and therefore so will PRC capability. "Inbound isn't going to stop," he explains. "There will always be different challenges coming into the China market. There is a lot of legal work coming out of that.
"Our ambition is to grow in the inbound and outbound areas. For outbound it's about the client relationship. It could be that having a joint operation in the SFTZ with a Chinese firm might be the right way to go [for developing those relationships]."

What the locals say
So how about the locals? Following the merger between China's top-ranked King & Wood and Australian leader Mallesons Stephen Jaques, the market has been rife with rumours of Chinese firms looking at tie-up opportunities with foreigners, but so far little has come to fruition.

Evidently, there needs to be a desire to combine from the local side if the SFTZ is going to have any real impact.

"I think it depends – different firms have different strategies," comments Chinese lawyer Michael Gu, formerly a partner at Zhong Lun Law Firm in Beijing but now part of the spin-off outfit AnJie Law Firm. "There might be an incentive for some firms – probably mid-sized or boutique firms as they want to keep their large clients. But I think many PRC firms may be reluctant to have an exclusive arrangement with international firms as they would lose the opportunity to cooperate with others."

There is no doubt that Gu's opinion resonates among many local partners. Though a merger arrangement could be useful in creating a global brand name, they believe a tie-up could run the risk of cutting off referrals through the suggestion of exclusivity. And even in the case of a KWM-style combination, local partners say that without
true financial integration the upsides would likely be limited.

Guangdong rising
Putting further pressure on the SFTZ is the fact that there are opportunities to financially integrate in Guangdong. The June 2003 signing of the Closer Economic Partnership Arrangement (CEPA) between the mainland and Hong Kong allowed firms from the PRC and Special Administrative Region to establish formal associations. Unlike alliances based on business contracts, whereby firms commit to joint-pitching arrangements, this model means firms can formally collaborate, share office space and participate in joint marketing activities.

So far a handful of international firms have taken advantage of the arrangement. Clyde & Co, for example, finalised an arrangement with PRC firm West Link in the South West city of Chongqing under the model in October last year. As part of the deal it is also permitted to have two more associations elsewhere in the country.
Provisions allowing financial integration didn't come along until August this year, but are potentially far-reaching. Taking effect on 1 September, the new rules, which still come under CEPA, specify that Hong Kong and mainland firms can now form joint law ventures as separate legal entities, known as 'specialised general partnerships', located either in Qianhai in Shenzhen, Nansha in Guangzhou or Hengqin in Zhuhai.
The downside is that not all international firms can set up these partnerships, limiting the benefits of Guangdong. For US players in particular, many of which have only had Hong Kong offices for a short time and boast much smaller practices, the SFTZ might still be their best or only opportunity for a combination.

So the question remains whether or not China will deliver on its pledge to open the market for law firms. Unfortunately, following years of empty promises, the industry is yet to be convinced.

"I'm glad we have a Shanghai office," comments Matthew Bersani, the Asia managing partner at Shearman & Sterling, who says the SFTZ is good in theory. "We continue to believe that being in Shanghai has to be important for an international firm. It is true that Shanghai has not generated as much work as many firms expected, but we continue to think it makes sense to be there."

However, he believes more tie-ups between local and international firms are a long way off: "If that ever became possible then we would seriously look at it, but we don't think that's likely in the near term at all – they're just too protectionist. How long have they been talking about that in India? 20 years? Nothing will happen. China is still for most firms a waiting game. A lot are fed up with it because it's been 10-15 years and where's the pay off?"

Paul Abfalter, general counsel at Australian telecoms giant Telstra International, is equally cynical: "The jury is still out on the SFTZ. For industries such as ours, it's going to have very little impact unless there is nationwide reform and it's too early to tell as to whether it's a stepping stone. Anything could happen. We'll see how it evolves over the next six to 12 months but we're not massively excited. We're an industry that [has endured] a long history of teasing from the mainland and heard many announcements, but had no follow through."