The Curtains Close: Reflecting on the Legal Sector, 2022

In the spirit of reflection and the dawning new year, this article casts an eye on some of the most significant events which have impacted the legal sector in 2022. It also observes some of the issues which law firms will have to grapple with as we enter 2023. The ramifications of the pandemic, Russia’s invasion of Ukraine, as well as talent retention and attrition related issues are amongst the most significant events which have contributed to the instability suffered by the markets this year, with some of the consequences manifesting in the rise of inflation and the energy and cost of living crisis.

Energy

Taking the energy crisis as an example, 28 energy companies had declared bankruptcy by the end of December last year. In response, law firms have bolstered their energy capabilities encompassing infrastructure, renewable energy, and project finance. This strategic recalibration is exemplified by several significant departures from UK headquartered outfits to US firms, which are particularly excelling in this space. Examples of these departures include Sara Pickersgill and Toby Parkinson who join Kirkland & Ellis from Allen & Overy and Clifford Chance respectively, as well as Matt Hardwick who joins Akin Gump from Norton Rose Fulbright.

The Recession & Inflation

In June, inflation in many countries hit levels not seen since the 1980s. Seemingly, everywhere, poorer populations were squeezed by rising costs for life’s essentials: energy, shelter, clothing, and food. Inflation became the number one concern among executives responding to McKinsey’s Global Economic Conditions Survey, supplanting COVID-19, and geopolitical instability- both of which were higher on executive’s agendas at the beginning of the year. Regarding the impact of on the legal sector, commentators have observed that Britain’s largest international law firms are struggling to attract and retain staff in the US after the crash in the value of sterling compounded by their lack of competitiveness in the world’s most profitable legal market. Furthermore, existing senior staff, concerned that foreign exchange would further erode their salaries, have also asked for their pay to be increased or pegged to the dollar.

The current situation may be particularly concerning for top tier UK firms including the likes of the Magic Circle, which historically struggled to match their American competitors on pay due to lower overall profitability and more restrictive remuneration models that prevented outsized salaries for star partners. For example, Freshfield’s equity partners took home more than $2mn each on average for the year ended April 30. However, its profitability remains well below that of the top US law firms, where partners’ average take home profits exceeded $7mn. The widening gap between the pound and the dollar further hinders London-based firms’ ability to hire top talent.

Key Consideration for 2023

Leading up to the new year, law firms will face numerous challenges, such as the aforementioned shortage of talent, cyber risk, macroeconomic uncertainty, and the inability to recover costs through pricing.

The War for Talent, Retention, and Attrition

The shortage of talent issue has been identified as the leading concern for law firms. Since the end of the last lockdown, partners and fee earners have been on the move more so than at any time in the last two years. Estimates indicate that movement in the London legal market in 2021 has seen 2564 lawyers across 382 firms take the leap departing from their respective firms, meanwhile 2020 saw 2014 across 408 firms make the transition. Presently, the numbers for 2022 stand at 1679 across 318 firms taking this leap. Movement has been most prevalent in the disputes space followed by corporate, banking and finance and real estate. Statistics indicate that the Silver Circle and Magic Circle firms have seen the most attrition, with Kirkland & Ellis leading in the number of hires made in the last 3 years.

However, the same source indicates that both the Magic and Silver Circle respectively have been pushing back and filling vacancies. This is arguably a clear indication that the Magic and Silver Circle maintain their position as premier outfits for associates seeking some of the best training and quality of work. Nonetheless, it is also clear that individuals are now considering the trajectory of their careers, with the US outfits offering an attractive alternative to their counterparts.

The war for talent, coupled with the shortage of supply exacerbated by the so called “Great Resignation” have caused eye-watering staff cost inflation. In response, many law firms have revived and refined their salary offering. A notable example of this includes the likes of Akin Gump raising salaries of newly qualified lawyers from £159,000 in the first quarter to £179,000 for the period covering July to September. However, commentators note that it will take more than remuneration to retain talent, particularly after the pandemic where individual focus shifts to considerations such as the opportunity to work from home and the improvement of work life balance.

Cyber Risk

With the rapid technological advancement and introduction of new technologies to the mainstream, firms will have to grapple with the changing needs of their clients. However, they will also need to focus on the foundations underpinning this work, and that is the security associated with it. Cyber risk continues to increase as hackers become more sophisticated and implement new forms of attack. It is clear that law firms are responding to this risk with a significant increase in cyber security spend in the last year. The rise in spend across the top 100 bandings is between 50% and 79%. However, commentators note that this spend may have to increase further, and add that in the current year, it only stands between 0.3% and 0.5% of the fee income across the bandings. The focus on cyber risk is and technology more generally in the sector is also reflected on the client side, with statistics demonstrating a growth in IP/IT related work.

Macroeconomic Uncertainty

The uncertainty in the economic environment has been bubbling for a few years and the onset of the Ukraine/ Russia conflict has seen a significant shift in short to medium confidence. High inflation and the tightening of credit markets have led to nervousness about valuations and slowing of the deals market, although the weakening of sterling will increase the deal flow for foreign buyers. The currency impact on results FY23 looks set to be more significant than seen for a number of years, rewarding those firms with greater international presence.

Predictions for 2023

Commentators predict that demand for legal expertise is expected to decrease for a variety of reasons including rising inflation, new regulations and sanctions, and the threat of a recession, according to data from LexisNexis’ latest Gross Legal Product (GLP) index. The index, which highlights areas of law that are growing or falling in demand, predicts that this will affect the demand for corporate law the most, forecasting a decline of 22% compared to last year by the end of 2022 as corporate transactions and IPOs dry up.

By contrast, competition lawyers are expected to see a strong increase in demand of 17% to the end of the year, a trend that is expected to continue into 2023. This comes off the back of the Competition Markets Authority’s growing interventionism as well as new security and sustainability measures amongst other things. Moreover, the UK and the EU recently extended the reach of their competition enforcement, and companies can expect enforcers to bring more cases. It may become difficult to predict which mergers will attract attention in which jurisdictions, and the costs of navigating merger clearance will increasingly impact which deals get done in 2023. But because the vast majority of deals close, even following intense scrutiny, more review will still translate to a deterrent, rather than a deal killer, in the new year.

The mergers and acquisitions market continues to be described as “slow” and “uncertain,” and those trends are likely to continue into the new year. Despite this outlook, the 2023 deal forecast may not be as dreary as some predict. M&A activity in 2021 reached historic levels, and it’s hard to beat records year after year. So, 2023—even if slower than 2022—could represent a return to normal in the M&A market.

Additionally, the rise of ESG over the past several years has cemented investor interest in incorporating environmental and social impacts into the financial investment equation. Next year, human capital management will be at the forefront of the conversation, and we’ll see investors looking for more disclosures to ensure that they are investing in companies that align with their values.

 

Sources

Financial Times, UK’s ‘magic circle’ law firms struggle to grow in US amid sinking pound, https://www.ft.com/content/fab70e6e-52fb-4f70-ba82-5f4880545426.

PwC, Agility through turbulent times, PwC Law Firms’ Survey 2022, UK law firms demonstrate their agility through turbulent times – PwC Law Firms Survey / Law+Firms+Survey+2022.pdf (pwc.com).

McKinsey & Company, What just happened?, McKinsey Publishing’s year in review, What just happened? McKinsey Publishing’s Year in Review | McKinsey & Company.

Legal market to ‘cool substantially’ following post-lockdown boom, Legal market to ‘cool substantially’ following post-lockdown boom – Legal Cheek.

ANALYSIS: 2023 M&A Market May Reveal a Return to Pre-2021 Levels, https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-2023-m-a-market-may-reveal-a-return-to-pre-2021-levels

ANALYSIS: Antitrust Battles to Become Even More Heated in 2023, https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-antitrust-battles-to-become-even-more-heated-in-2023.