UK law firms must adjust their business as factors such as Brexit and the rise of the accountants squeeze a market that is already under huge pressure, according to the latest NatWest legal sector report.

The report, previously issued under the Royal Bank of Scotland's banner, looks at what lies ahead for UK law firms and suggests that activity levels are likely to suffer, particularly in areas such as real estate.

James Tsolakis, head of the legal sector within UK corporate and institutional banking at NatWest, says: "We haven't had any material shocks yet as a result of Brexit but they will come – let's not be complacent. It's a doubled-edged sword. It's very threatening in terms of volume and value of transactions, and the forward-thinking firms are already planning for the adverse consequences by looking at right-sizing and jobs coming out of the sector.

"The other side of that is more advisory work for the duration of the process – but not everyone will be the beneficiary of that."

According to Tsolakis (pictured), combined with structural changes taking place in the legal sector, the profession could comfortably see a reduction of 5% in lawyer numbers in London.

The more challenging market conditions combined with the continued movement towards bigger firms will make organic growth more difficult to achieve, according to the report, driving further consolidation.

"The accountants and US firms are also a threat, and all of this will squeeze the mid-tier more," says Tsolakis. "It will cause a profitability challenge, particularly as the increases in associate salaries inflate the cost structure of law firms, leading to greater pressure on margins."

A particular post-Brexit threat for UK firms is the advantage that the weaker pound gives US firms when it comes to recruitment. This, when combined with the longstanding higher profitability of US firms, will pile additional pressure on both lockstep and law firm cost structures.

"The fall in sterling means it is now 20% cheaper for US firms to buy in talent than it was a few months ago, which is a threat to the magic circle and mid-tier," says Tsolakis. "Top-end talent is being squeezed out, which is challenging lockstep and putting the whole law firm compensation model in question, as sterling has weakened.

"When you overlay the fall in sterling with the profitability challenge and the squeeze from Brexit, the law firm model is changing. Law firms need to move from a fixed cost structure to a variable one so that they can adjust in line with activity levels."