‘The ground rules have changed’: Dentons’ retreat exposes China risks

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Months before global law firm Dentons decided to decouple from its Chinese affiliate Dacheng, its staff in western nations were advised against travel to the country.

Some professionals who had visited China were “delayed by many weeks” when they attempted to leave, a person close to the firm said, prompting a policy change. Chinese authorities also made multiple “visits” to Dacheng sites, two people familiar with Dentons’ decision this week added.

Facing an increasingly hostile environment, the largest global law firm by personnel quietly retreated from the country on Monday. It told clients that due to “new mandates and requirements relating to data privacy, cyber security, capital control and governance”, it would sever its official relationship with Dacheng, according to an email seen by the Financial Times.

Dentons partners were quick to reassure clients that the firm would continue to refer work to Dacheng, in a “seamless” transition, and that its Hong Kong practice, which handles the biggest Asian deals, would remain untouched.

But the implicit message from Dentons — that China was no longer a place global law firms could easily do business — raised eyebrows across the industry. The firm had been the flag bearer for Chinese integration when it merged with Dacheng in 2015, proclaiming to be “uniting East and West” and even incorporating Chinese characters into its new combined logo.

“They are being forced to unwind one of the most historic law firm mergers,” said Kent Zimmermann of Zeughauser Group, a consultancy that advises some of the legal sector’s biggest players. “They didn’t really have a choice.”

At issue for Dentons was the recent broadening of Beijing’s anti-spying rules. In April, China said the regulations would now cover any “documents, data, materials or items related to national security and interests”.

As a result, people familiar with Dentons’ decision told the FT, the firm was unable to share information freely between Chinese and non-China based partners, rendering it incapable of performing basic conflict of interest checks or of carrying out due diligence on China-related deals.

“The ground rules have changed,” the person close to Dentons said. With “no way around” such restrictions, it became impossible to guarantee to clients that “your secret is safe with us”, the person added.

Law firm leaders have also watched with horror as Chinese security officials carried out a series of raids on foreign companies in recent months, including western advisory firms Mintz Group and Bain.

The question now is how many will follow Dentons lead, and hive off operations in one of the world’s largest markets. New York-headquartered firm Proskauer Rose said in June that it would close its mainland China office, while Ropes & Gray is “shifting some of its China-based resources to Hong Kong”.

“I think this gives many firms cover to do what they already wanted to do, which is to leave China because they find it untenable to work there,” said Zimmerman. Privately, some law firm leaders have expressed similar concerns.

However Dentons’ announcement was met with scepticism by others at global law firms with longstanding practices in the region.

“I don’t believe the China regulatory issues are the real reason,” one Chinese-based partner at a rival US law firm told the FT. When the Dentons-Dacheng merger was announced in 2015, they said, “many of us in the foreign legal community were sceptical”.

“The real reason this is a non-starter is that the size of this combination creates insurmountable conflicts of interest and results in a clash of cultures, professional ethics and governance,” added the partner, who has been practising in China for decades. “They claimed to create the world’s largest law firm with 6,600 lawyers in 120 offices in 50 countries. That’s just unworkable.”

Dentons declined to comment.

The firm’s effective departure from China comes amid a wider economic slowdown in the region, especially when it comes to cross-border transactions, as geopolitical tensions between the US and China weigh on investors. The value of merger and acquisitions from China total just $221mn so far this year, according to data from Dealogic, compared with $3.4bn at the same point last year. The country’s economy has also expanded by an anaemic 0.8 per cent between the first and second quarters of the year.

Despite the worsening business environment, some global firms have been increasing their presence in China in recent months. US-headquartered Morgan Lewis announced it was opening a new office in the southern city of Shenzhen last month, while the UK’s HFW said in June that it was adding an office in the Greater Bay Area — its seventh in the region.

Many of Dentons rivals already have arrangements to refer work to specific Chinese firms, rather than an official presence in the country. Eversheds Sutherland became the latest to announce such a formal co-operation agreement last month, in their case with King & Wood Mallesons in China.

Other law firm leaders suggested their firms were able to continue doing business in China under the local rules, and that the greater threat to their prospects was the US or EU imposing restrictions on western lawyers representing the country’s state-owned enterprises. A person close to Dentons suggested that they had been targeted first as “the Chinese government is focused initially on Chinese law firms” such as Dacheng.

Two days after Dentons’ decision, the Biden administration provided a further taste of what may be to come in US-China policy, announcing it would ban US investment into quantum computing, advanced chips and AI sectors in China, a move which will affect private equity and venture capital firms.

In Beijing, Xi Jinping’s administration, was “showing no signs of letting up”, the person close to Dentons warned.

“If you are foolish enough to think the scrutiny will not be extended to your operation . . . ” the person said of rival firms, “[you do so] at your peril”.