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Monday, 18 July 2016 15:27

Privatisation 2016: A New Phase

Taras Boroda, COSA Junior Associate

A new round of privatisation is coming to Ukraine, with the Ukrainian Prime Minister Volodymyr Groisman insisting it should start as soon as possible. Within this context, Ukraine is facing the following all-important question: will the major privatisation of 2016 increase the state government efficiency or become yet another example of power abuse and corruption, as it happened before?

In order to understand the current situation, we have to go back a few years and recall the lamentable experience of privatisation that illustrated the total corruption prevalent in Ukraine.

 

Privatisation of the largest and most viable businesses always attracts the attention of oligarchs. In the past, no important deal could go through without their influence. Unique conditions were imposed to prevent international companies and any other businesses not connected to the oligarchs from participating in the auctions. As should be expected, the deals were often unfair and the prices ludicrously low. A stark example of this was the privatisation of Kryvorizhstal in 2004.

When discussing unfair play, we cannot overlook the 2009 attempts to privatise the infamous Odessa Portside Plant (OPP), one of the most recognizable lots at the grand Ukrainian auction. Back then, a company belonging to the Privat Group had won the “contest”, but half an hour later, the State Property Fund of Ukraine cancelled this decision, highlighting the fact that the authorities had direct control over the bidding. In the ensuing legal battle the ultimate victims were, as always, the budget of Ukraine and Ukrainian taxpayers.

Starting from 2010, “grey schemes” accompanied the privatisation of other businesses, including Ukrtelecom, Ukraine International Airlines, and Kyivenergo. As part of selective privatisation widespread at the time, interested parties purchased enterprises at bargain prices determined by the State Property Fund of Ukraine.

In 2015, after the regime of Victor Yanukovych was ousted, the then-Minister of Economy and Trade Aivaras Abromavičius started a massive privatisation campaign. In Decree 271 of 12 May 2015, the Ukrainian Cabinet of Ministers approved a list of items subject to privatisation. Among the 342 items on the list, there were the Odessa Portside Plant, Ivano-Frankivsk Locomotive Repair Plant, Sumykhimprom, a number of regional power distribution companies, heating power plants, numerous mines, and almost all the major ports of Ukraine.

However, according to the State Property Fund report, privatisation generated 153 million UAH in 2015, less than 1% of the 17 billion UAH planned by the Fund and included into the 2015 budget.

What prevents privatisation in Ukraine from going according to plan?

Since the beginning, there were doubts as to whether strategically important enterprises should be privately owned. It is a debate where the opposing sides will not reach consensus any time soon. Major state-owned enterprises that generate nothing but heavy losses and debts are, however, an acute problem under the current circumstances. Those officials who oppose privatisation usually control massive flows of money through their enforcers and have no desire to leave their lucrative positions. Money laundering schemes through state-owned enterprises are nothing new either.

One of the simplest and most widespread examples of this type of corruption is intentionally striking lossmaking deals with offshore companies that belong to the firms connected to government officials or directors of state-owned enterprises. Such schemes are often employed and developed at the infamous OPP. Therefore, privatisation can have a positive effect, but only if it is carried out in a fair and transparent manner.

Among the problems which have been hindering effective privatisation for many years is the lack of laws that meet the requirements of the times. For instance, the privatisation procedure itself can take more than three years, which is far too long. Ihor Bilous, the Director of the State Property Fund, is of the opinion that privatisation was unsuccessful since businesses could not be sold transparently within the old legal system. Moreover, for the purposes of privatisation, enterprises regulated by various ministries should be placed under the management of the Fund, but this process is constantly stonewalled (in 2015, only 12% were placed under the management of the Fund).

We should mention that Petro Poroshenko, the current President of Ukraine, had enacted the bill On Amendments to Certain Legislative Acts of Ukraine Concerning Privatisation Improvement, which was passed by the Verkhovna Rada on 16 February 2016. Several positive changes are worth highlighting:

·       The disclosure of information on anyone who buys shares of a state-owned enterprise, not only those who purchase more than 25% of shares.

·       Previously, the law demanded that 5-10% of shares were first sold at the stock exchange to determine their fair price. This provision has now been cancelled. Experts believe that, since the Ukrainian stock market is underdeveloped, interested parties can easily manipulate such prices, making them nowhere near fair.

·       Representatives of the aggressor state, i.e. Russia, can no longer take part in privatisation.

·       Independent advisors will be invited to consult during privatisation of Category G businesses (major strategically important enterprises).

Thus, the process of transparent privatisation is apparently underway, but it is uncertain whether investors will find it satisfactory. Their concerns are fully justified, with the ongoing war being only one of many factors. It is difficult to imagine a major business successfully operating in Ukraine without corrupt practices, illicit payoffs, and patronage in courts and law enforcement agencies. Corruption permeates all stages of business relationship between the state and private sector. The long-developed system of all-round patronage and nepotism, as well as fiscal and law-enforcement authorities pressuring honest businesses undermine every effort to make Ukraine more appealing to investors. For this reason, investors are reluctant to purchase Ukrainian companies, and they are afraid of becoming involved in such practices for their business to survive on the Ukrainian market.

Apart from unfavourable circumstances, it should be noted that Ukrainian economy had probably hit rock bottom and from there, the only way is up. Thus, now is the moment when investments are risky, but extremely profitable at the same time. Since new rules prohibit Russian companies from participating in privatisation, most purchases will probably be made by companies from Western countries, India, and China.

As privatisation in Ukraine is closely monitored by foreign investors and donors, international experts, anticorruption agencies, activists, and the Ukrainian public, there are reasons to hope that this time, bidding will be truly transparent and honest. Advisors will play an important part in this process. According to the new law, they will be invited as consultants to gather information, analyse economic, technical, and financial performance of businesses, bring bookkeeping reports in accordance with the standards of accounting, carry out independent audit, determine investment prospects and ways to improve them, find efficient methods of loan restructuring, recommend basic prices and rates for products and services, and advise on marketing policy and other measures. Moreover, the invited consultants will provide independent assessment to determine the value of shareholdings and submit a report on property appraisal to be approved by the state privatisation body.

With foreign companies taking part in the bidding, auctions rise to a new level where it will be necessary to comply with international standards in a number of instances. Businesses will be subject to scrutiny based not only on their financial standing, but also on their current business ties, problem areas with regard to reputation, and compliance with ethical and legal standards. In other words, due diligence and compliance procedures will be employed, the same procedures that have long since become the norm in developed countries and often are a major factor in strategic decision-making together with other methods of risk assessment and mitigation. These procedures help determine whether a business has any problem areas, provide an independent assessment of a company for investors while taking into account all the aforementioned particulars, and ultimately speed up the sale of state-owned assets.

 

 

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