For more than 25 years foreign law firms have dominated legal services in China in a determined attempt to mop up their share of the torrents of foreign capital that have flowed into the Middle Kingdom.

The early arrivals headed for Beijing, but, as the market has matured, Shanghai has become the destination of choice as the city races to overtake Hong Kong and Singapore as the region’s commercial and financial hub. It is stamina that counts in this market, not speed.

Two hundred and eight foreign law firms have licences to practice in China. Of these, 29 UK firms have a presence on the ground with representative offices in Beijing (12) and in Shanghai (17), and five of these having established second offices. US firms have almost double the British presence in the People’s Republic of China and Hong Kong-based firms consistently edge UK firms into third place in the league of leading non-domestic players.

How are UK firms fairing? “Competition is robust,” Jon Harris, of Pinsent Masons, says, “but there’s plenty of work to go around and we expect this to continue for as long as China’s economy continues to flourish.”

Historically, foreign direct investment has made up the core workload for most foreign law firms as multinational corporations and the more ambitious small and medium enterprises seek to enter into, consolidate or expand their presence on the mainland. However, changes are afoot. Jane Newman, of Simmons & Simmons, notes that “the market is in transition and the pace of change is speeding up”.

China has so far been insulated from the reverberations of the global credit crunch, but as the nation’s economic growth is largely predicated on exports to Europe and the US, it is only a matter of time before the big squeeze is felt. The effects of this will be exacerbated by the blunting of China’s market edge as it loses some of its advantage as a low-cost manufacturing centre to other countries in the region, such as Vietnam, which are gaining a stuttering momentum of their own.

Long mindful of this, the Chinese Government has been directing the market towards a new phase of development in which more sophisticated business opportunities are emerging. Inbound investment is becoming smarter: multinationals are refining their long-term strategies, life sciences and pharmaceutical companies are eyeing China as a potential location for research and development centres, foreign banks are exploiting the recent liberalisation of banking laws and IT companies look to capitalise on China’s bid to outstrip India as the world’s outsourcing centre.

A sure sign of the maturation of the market is the gradual turning in the direction of capital flows. The expansion of foreign firms hedge fund practices mirrors the development of the qualified domestic institutional investors regime (which allows Chinese investors to place their money overseas), and the apparently insatiable Chinese appetite for foreign technology and cross-border merger and acquisitions continues unabated. It is in this sector of the market where the more experienced foreign players have the edge over their local counterparts.

Even so, the smart money is betting that it is only a matter of time before the legal market thins out as second and third-tier foreign firms hand back the keys to their trophy offices and return to home base a little wiser. According to Graeme Johnston, managing partner at Herbert Smith’s Shanghai office: “Many foreign firms have entered the market without any clear strategic goals or distinctive commercial offering and as the market becomes more complex there will be a shake-out of those firms that don’t offer real value to clients.”

The local profession, once devastated by the excess of the Cultural Revolution, is consolidating its natural advantages in terms of cultural savvy — never to be underestimated in any emerging market, particularly China’s — and augmenting its skills base through the insight and experience of those Chinese lawyers who have worked for the international players either at home or overseas. They are eagerly lining up their cost advantages and business connections to step into the gap left by those departing foreign firms weary of their continuing losses.

In line with World Trade Organisation commitments, the door to foreign firms remains open. However, in 2006 the Shanghai Lawyers Association issued a menacing memorandum castigating foreign law firms for alleged breaches of practice regulations, specifically, for advising clients on matters of Chinese domestic law. So, the legal market in China is best seen as a marathon, rather than a sprint.

It is those firms with a long-term strategy for providing the high-end services that are out of the technical ambit of most local firms that will endure, but it is set to get lonely for these long-distance runners as they glance over their shoulders to see the local pack fast approaching, rule books in hand.

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