In 2014, three factors seem to have had the greatest influence on our legal market: further intensifying competition, marked local/regional (geo)political developments and the slight recovery in the global economy. Due to the diversity of the economic, social and cultural backgrounds of the CEE countries as well as the differences in the maturities of the local legal markets, the above-mentioned three factors have had different impacts on these jurisdictions. As I know the Hungarian market better than the other CEE markets, I will illustrate the combined effect of these three factors by presenting a snapshot of the Hungarian legal market.
In Hungary, political developments have been having the most profound impact on the legal market. The Hungarian Government has articulated clearly that one of its key objectives is to transform the “strategic sectors” by increasing Hungarian ownership in these areas, with a simultaneous decrease in foreign influence. This interventionist policy has had a double impact on the Hungarian market for legal services. On the one hand, it has decreased the demand for Hungarian legal services, given that entire sectors have lost their attractiveness as potential investment targets for foreign financial and strategic investors. The “emergency” and “sector” tax-riddled banking, energy and media industries are prime examples of such “devaluation”. The plunging FDI numbers clearly show the decrease in capital inflows and the absence of high-value inbound acquisitions. Further, because of high tax burdens, the companies that operate in these sectors have become extremely cost-conscious, adopting measures such as limiting their use of outsourced legal services and creating price competition between outside advisers. As a result of all the foregoing, there is a continuing drop in the demand for “ordinary” legal advice, from both potential and existing clients.
On the other hand, the Government’s activism has triggered substantial demand for specialist legal services, from both the Government and the private parties affected. To mention but two examples: the repurchase of formerly privatized strategic companies by the Government and the complete re-regulation of entire sectors (from energy to the trading of alcoholic beverages and tobacco) have provided opportunities for local transactional, regulatory and litigation teams, and have often necessitated input from their integrated or best-friend offices in the West and/or also in the East. This type of “emergency engagement” has come from the Government as well as the private sector players that were impacted by the new government policies. Accordingly, although not completely, to some extent the extra demand for specialist legal services created by the interventionist policies has counterbalanced the decreased demand for “ordinary” legal services.
It is an undoubted phenomenon of the Hungarian legal market that the public sector has become one of the largest sources of legal work for many local and some international law firms. As public sector clients often require a different type of client care, one can see a clear segmentation among these legal services providers’ quality, responsiveness and application of international professional rules such as FCPA or the UK Bribery Act. It’s been interesting to learn that the Government is now contemplating to set up one or more centralized legal panels to replace the currently highly mixed, ad hoc and fragmented legal adviser pool with a more homogeneous, selected group of quality advisors. As one can bet competition to get on these panel(s) will be huge.
Looking ahead to next year, there are already some signs that this process will continue. In the coming years, I also expect significant transactional activity. Although it does remain the case that a substantial part of the workload is still “outside the ordinary course of business”, for those law firms that have a quality offering in sophisticated services, the outlook is not all gloomy.
First, exits of foreign strategic investors from the strategic sectors (banking and energy being the hottest areas) are expected to continue.
Second, the Hungarian Government has already articulated that it does not intend to own the repurchased/re-nationalized strategic companies (e.g. banks) in the long run but plans to transfer them to Hungarian investors (via trade sale or IPO).
Third, the relatively high proportion of non-performing loans (NPLs) in Hungarian bank portfolios remains a grave problem for the Hungarian finance sector. The establishment of a “bad bank” by the Central Bank of Hungary (MNB) in November 2014 is expected to stimulate the NPL market. Further, once the re-regulation of the banking sector has been completed and the banks have a clearer picture of the way forward, they are expected to become much more active in the clearing of their distressed portfolios. Accordingly, the dynamics in the NPL market are not simply the result of the intervention by MNB. Similar tendencies can be observed in the entire CEE region: investors are showing a growing interest for investing in NPLs in the region, attracted by improving economic conditions, returning optimism and overall a less competitive loan sale market than in Western Europe.
Fourth, there appears to be a segment where “life is normal”: this is the segment of innovative Hungarian start-ups. This segment has not appeared to be adversely affected by high politics. Acquisitions of such companies by Western European/US financial and strategic investors have continued and are expected to continue, going forward. These are not huge transactions, nevertheless they do create some opportunities for “usual” transactional advice.
Finally, it has also become apparent that those manager-owners who acquired their business via MBOs during the privatizations in the 1990s have arrived at a turning point. These manager-owners are now in their late 60s and, where there is no intention/possibility of passing on the business to the next generation, an exit is inevitable. This type of engagement has recently become visible in the legal market and it is definitely expected to intensify, given the relatively positive market sentiment.
However, notwithstanding anything stated above about the current or expected dynamics of the Hungarian legal market, one overriding force remains: the cut-throat competition. It is a hard fact that the overall supply of legal services continues to significantly exceed overall demand – it is therefore the buyers who dictate the price and the terms, be it the client, the Government or a private sector company. In this connection, it is also clear that the brand value of the most prestigious law firms seems to be losing its lustre – clients (including general counsel) now increasingly select outside law firms based on price and efficiency and not on reputation alone. The times seem to have passed when the complex, large-scale matters were “reserved” almost exclusively for “to go”/”magic circle” law firms. Regional champions and law firms of the “large enough” category have emerged as able competitors to the privileged elite. This reshuffling is very clearly present in the Hungarian legal market. The increased price competition and the lack of mega deals comparable to those in Western Europe and the US (with their mega fees) of course put an enormous pressure on law firms in the CEE and very heavily test the adaptability of their respective operational models. Accordingly, the recent exits by major international law firms from the CEE markets are most likely not the last ones.