Ukraine inherited a huge number of state-owned enterprises from the Soviet past. Often they are either inefficient, or used for enrichment of those who find corrupt schemes to exploit their resources.
In the text below we analyse major challenges and possible ways of reforming the state-owned segment in Ukraine.
Why to reform state-owned enterprises? In Ukraine, there are about 3,500 SOEs. This is a rough number as it does not account for assets outside SOEs’ authorized capital, like factories, hospitals, health resorts of the national railway company Ukrzaliznytsia or, for example, hotel of Odesa Portside Plant. However, the fact that now due to inventories we know all the SOEs will allow to follow them and control their activities.
Out of the mentioned 3,500 SOEs, only about 1,800 are functioning. Others are being liquidated or bankrupt. The functioning SOEs in most cases bring losses to state budget. CEOs often use enterprises to enrich themselves. They can buy overpriced goods or services and sell products at prices lower than the market ones. In both cases, these executives get rollbacks. The resulted losses for SOEs are usually covered by state budget, i.e, from taxes paid by Ukrainians. In other words, CEOs steal budget money consisted of Ukrainians’ tax payments. For instance, Anti-Corruption Bureau of Ukraine is investigating corruption at Ukrzaliznytsia. Some its managers are suspected in buying overpriced fuel and components.
A possible way-out from this situation is privatization. A private owner’s capacity to manage an enterprise is much higher than the state’s one. He/she will be interested in profit. Therefore, privatized companies will pay more taxes to the budget, and this money could be used for social welfare programmes. Taxpayers will not cover SOEs’ losses anymore. It can lead to reduced corruption.
However, the executives could still bribe a regulator to overprice some goods, admits Tymofiy Mylovanov, a professor at the University of Pittsburgh and co-founder of VoxUkraine independent platform. Thus, corruption could be transferred from state budget to regulator. And this could lead to price increase of some goods.
A solution for strategic SOEs, which cannot be privatized, is corporate governance. They must be managed not by the government, but by independent experts and professionals who act in the best interest of the enterprise. This kind of management can be more efficient.
Corporate governance and transparent privatization are also among Ukraine’s commitments to the EU (the Association Agenda) and the IMF.
How Privatization Evolves. In 2016, Ukraine improved privatization conditions to attract more buyers, including foreign investors. No more mandatory sale of 5-10% of shares on stock exchange before an auction. As a result, investors can buy more shares during the auction, and their price is higher (each share of 5-10% stakes costs less than each share of controlling stock). Potential buyers can check what property is for sale via privatization.gov.ua webpage. It also allows to sell up to 70 objects at once.
Small-scale privatization has become more transparent. An exclusive way to buy or sell small-scale objects is via electronic auctions. Currently, Ukraine is working with 17 stock markets. Other novelties include Dutch auctions to sell non-liquid objects. Here the seller lowers starting price until a participant agrees to buy it. Moreover, a person or an entity from an aggressor state, an offshore zone or the one involved in money laundering (FATF list) cannot participate in actions.
Now any dispute can be settled via international arbitration, instead of corrupt Ukrainian courts. To prevent delays in privatization, in January 2017, Ukrainian government streamlined the procedure of property transfer to the State Property Fund. Now absence of some documents cannot delay privatization. The State Property Fund still receives property from the SEO to sell it.
Privatization: what next? Currently, the State Property Fund and the economy ministry together with Baker&McKenzie law firm have developed a new law on privatization. If approved, it will improve the mechanism to define starting price of property. Now appraisers often overprice property, assessing its cost, not a possible revenue. The bill proposes to remove the institution of appraisers. Instead, professional advisers will define starting price for large-scale objects considering demand for these objects. For small-scale privatization, the highest price proposed by investors will be starting. As a result, starting price will be market- based.
Moreover, the new draft law proposes to use for small-scale privatization ProZorro.Sales platform (Ukraine’s unique know-how developed for public procurement) to remove human factor. Here state property will be sold online. So you can buy an equipment or a factory as a book via Amazon. No more arrangements in smoke-filled rooms. All information about buyers, lots, and results will be public.
For delays in transferring objects to the State Property Fund for sale, the new draft law foresees financial sanctions. These delays have been used before to hinder privatization. The law gives potential buyers more time to decide whether to bid, not 45 days as it is now, but 180. Moreover, there will be no complicated classification of SEOs on groups, large-scale and small-scale objects, instead.
2016: Results of Privatization. The State Property Fund planned to earn UAH 17,1b (about €600m) in 2016. However, it has earned only UAH 331m (about €11m). This is mainly due to delays with the privatization of Odessa Portside Plant and regional power distribution companies. And despite the promise to sell them to the IMF. The Odessa Plant has not been sold because of its outstanding debt. The energy companies – mainly due to uncertainty in Ukrainian energy sector. The parliament has yet to approve new rules of game. In 2017, State Property Fund plans to earn about UAH 17b from privatization.
What is to Be Done? The government has yet to allow privatization of a number of SOEs, including alcohol producers and stevedoring companies. Experts say that many of these companies, including the biggest alcohol producer Ukrspyrt, produce counterfeits which pose risk to human health. Privatization will help to deal with this social issue: there are more chances that private owner would not be interested in counterfeit production.
Moreover, Ukraine has promised IMF the triage of SOEs to determine the ones for sale, liquidation, or continued state ownership. We must streamline the procedure to liquidate non-operating SOEs. Now it is too costly and lengthy.
Corporate Governance. Ukraine aims to depoliticize SEO governance, to protect it from a political interference by introducing corporate governance. In practice it means that SOEs must establish independent from ministries supervisory boards (SBs) and independent directors. Boards should consist of independent members outside of state service. They will act in the best interest of SOEs without politics to be involved. It is planned to create supervisory boards in 41 large-scale companies, including Ukrzaliznytsia (Ukrainian railways), Ukrposhta (postal service of Ukraine), Ukrhidroenerho (energy company), Ukrenerho (energy company), International Airport Boryspil. Ukraine also promised IMF to create SBs in 15 large-scale SOEs by the end of 2016 which was not fulfilled.
Corporate governance also envisions SOEs’ information disclosure. Reports, statute, salaries, deals with local authorities should be public. SOEs must conduct independent audits. Their results should be public too. Ukrainians, as a result, will have a chance to follow and control SOEs. Some large-scale companies have already audited and published results.
Case of Naftogaz. Naftogaz, Ukrainian biggest oil and gas company, is in process of developing corporate governance. It has completed the new charter, establishment of the Supervisory Board, approval of its structure. The transition period is envisioned till April 1, 2017. Moreover, energy ministry has transferred Naftogaz to economy ministry. As a policymaker, energy ministry often made decisions out of political rationale, not commercial interests of Naftogaz. After this transfer, this is no longer the case.
Supervisory board will be established also for JSC “Main Gas Pipelines of Ukraine” (MGU) and JSC “Underground Gas Storage Facilities of Ukraine”. These companies should be created in order to unbundle operations for gas transportation and storage from Naftogaz in line with the Third Energy Package. The MGU should have been already functioning according to the government plan.
SOEs’ Executives. Appointment of SOEs’ executives is more transparent now. This is due to competitive selection with the help of independent experts. The government influence is highly reduced. Ukrposhta (postal service) and Ukrzaliznytsia (railways) have already gotten their CEOs by this procedure. The selection for Mariupol Sea Commercial Port, Ukrhimtransammiak (ammonia transporter), and International Airport Boryspil is completed.
Selection process for CEO Eltrovazhmash (electrical equipment producer) has failed. Moreover, court canceled the appointment of CEO Ukrenerho (energy company). In order to draw effective and professional experts in SOEs, Ukraine has raised their salaries. The remuneration in private sector is usually much higher. So talents prefer to work in private companies. This salary rise should change the situation and attract more professionals to public sector. Moreover, Ukraine is developing the Key Performance Indicators (KPI) to incentivize creativity and efficiency of managers. They will receive bonuses for profit or sales increase, the successful completion of projects, inter alia.
Efficient Banks? State banks occupy enormous share of this sector. In order to attract more investments, Ukraine decided to sell them, fully or in part. In 2016 Ukraine sold to Chinese owner the Ukrainian Bank of Reconstruction and Development. It is going to sell Ukrhazbank in 2017, and 20% of shares of Oshchadbank and Ukreksimbank by 2018.
The reversed happened in 2016: the government nationalized and capitalized Pryvatbank. Why? The bank cancelled unsecured loans as they could not be returned. Plus, it spent more than earned. Not all borrowers paid interest rates, deposit rates were too high, as noticed by Oleksandr Parashchyi from Concorde Capital. Its bankruptcy could have led to financial instability. More than half of all credit cards, trade terminal, and ATMs belongs to Pryvatbank. At the same time, nationalization has increased state present in the bank sector to more than 50%, explains Mykhailo Demkiv, financial analyst. If sold to a private owner, he/she could become a monopolist due to a big share of Pryvatbank in financial infrastructure.
Conclusions. Ukraine has started to reform its state-owned enterprises. The main tools selected for this purpose are privatization and corporate governance. The long road is ahead. However, its success will reward all Ukrainians by reduced corruption, efficient governance, and profitable companies.
Text written by Ruslan Minich for UkraineWorld, Internews Ukraine
Illustration by Dmytro Zinchuk