Heading: Ports, Roads and Post Offices. What is Wrong with the Refusal to Sell State-Owned Infrastructure Enterprises?

OECD Guidelines on Corporate Governance of State-Owned Enterprises establish that only maximization of value for society may justify state ownership of an enterprise. Value for society can be maximized in different ways. For instance, if a state-owned enterprise (SOE) is as efficient as a private company in like business circumstances, privatization of such SOE would diminish its value for society as the state budget would lose dividends. If it is more beneficial to provide public benefit through SOEs than through procurement of goods and services from private companies, privatization is not going to be the best solution either. In addition, SOEs can ensure national security or perform regulatory function which makes their privatization unreasonable.

As a rule, in Ukraine SOEs make less than private companies do. Consequently, if such companies do not perform important security or regulatory functions, it is no use keeping them in state ownership. 

Providing public benefit through SOEs makes sense only if it is hard to monitor the scope and quality of such benefit if provided by a private company. In this case, expenses for procurement of goods and services and quality control will exceed expenses for provision of public benefit by SOEs. In addition, the agent-principal issue should also be taken into account. If at a certain point a private operator refuses to comply with the contract or demands that the prices be increased significantly, it will take time to find a new agent. In some cases, for instance emergencies, additional time is simply not available. That is why emergency services are normally owned either by state or by municipality. 

When we speak of national security or regulatory functions, the need for state ownership is apparent as it is the state that should guarantee the efficiency and perpetuity of such functions and with private entrepreneurs it is impossible for the state to have total control over their activities. What is more, with a company that is performing regulatory functions it is essential that there is no “takeover” by stakeholders who will try to maximize “their own” benefit instead of public benefit.

On October 10, 2018 the Cabinet of Ministers of Ukraine approved Ownership Policy for State-owned Sector of the Economy (Key Principles of Ownership Policy Implementation with Respect to Economic Agents Representing the State-owned Sector of Economy). This document relies on OECD recommendations for the most part. We tried to find out which public interests will be realized by the state through its companies. We shall start with infrastructure sector.

Key Principles of Ownership Policy Implementation with Respect to Economic Agents Representing the State-owned Sector of Economy stipulate that “governance agents approve separate ownership policies for companies that have particular importance for the economy of Ukraine”. This means that each large SOE (with assets that exceed 2 billion UAH or revenue of more than 1.5 billion UAH) has objectives of its operation determined and established in ownership policy. Company activities shall comply with the established objectives. Other SOEs are not obliged to have ownership policy.

Out of all the companies mentioned in Table 1, ownership policy is available at Ukrposhta, Ukrainian Sea Ports Authority and UkSATSE. All the three ownership policies contain commercial and non-profit objectives of enterprises (objectives that mean achieving economic and social results without the aim of getting profit). This analysis focuses on non-profit objectives of SOEs and aims at finding out whether these objectives justify state ownership for these companies.

Ukrposhta has four primary non-profit objectives set out in its ownership policy:

1. Ensure that universal postal services are provided across the territory of Ukraine;
2. Provide the opportunity for delivery of pensions and social payments to the citizens of Ukraine;
3. Distribution of periodicals and print publications via subscription;
4. Ensure that basic financial services are available across the territory of Ukraine.

In fact, these goals are the activities that the company runs. Is state ownership of Ukrposhta justified? Ukrposhta is the only company of this type that has national coverage. They are responsible for delivering pensions to pensioners who are not willing or cannot (for lack of bank offices or ATMs in their locality) get their pension via bank transfer. In addition, Ukrposhta provides a range of standard postal services – mail and parcel delivery, delivery of print media at regulated prices. Thus, they are providing public services – ensuring access to financial and postal services to citizens in small localities where it is not feasible to keep separate branch offices (private companies will not go for it). Ukrposhta is the only service provider for these localities and cross-subsidizes provision of public services via commercial types of its activities. 

In the future, we will need to single out records of income and expenses under important public services and consider the opportunity for buying them on tender. Then private postal and financial companies will compete with, hopefully, already modernized Ukrposhta for state contracts on delivery of periodicals, correspondence, parcels and pensions to small localities. 

In view of the size of Ukrposhta and the interconnection of its businesses (it is less beneficial to sell them separately), it may be hard to find an investor for 100% privatization. It is possible to consider the option of involving a strategic investor for minority stake during the first stage, for instance, find one among international financial organizations.

Among the non-profit objectives of UkSATSE SOE declared in its ownership policy we find servicing of air traffic, management of airspace use, organization and development of air navigation system of Ukraine, ensuring the activities and development of Unified Civil and Military Air Traffic System organization as well as organization and ensuring of aeronautical and maritime search and rescue. 

What we have here resembles types of activities rather than objectives of a company. Nevertheless, airspace management is connected to national security and, as mentioned above, maritime search and rescue must be ensured by the state. In addition, some of these functions lie within the realm of regulatory (organization of air traffic, management of airspace use etc.). So, in our opinion, it is more efficient to continue performing these functions through an SOE rather than delegate them to a private company.

Ukrainian Sea Ports Authority (USPA) has 15 non-profit objectives of a state-owned enterprise pursuant to its ownership policy. These include, for instance, the organization and provision of navigation security, collection and registration of data for the Registry of Sea Ports of Ukraine. In general, objectives that have to do with security, international obligations of Ukraine, rescue and aid to victims, keeping of state registries, provision of navigation and management of tugboat use are non-profit objectives of an SOE, which validate it being in state ownership. Other types of company activities can be performed by private companies. The necessity of state ownership for this company, except for the security aspect, is also justified by the fact that USPA has regulatory body functions. It is responsible for coordination of port activities and port infrastructure safety. Respectively, USPA, in our opinion, needs to remain in state ownership, yet some of its functions (for instance, organization of sunken ship raise) can be delegated to private contractors. 

Pursuant to Ministry of Economic Development and Trade triage, 12 ports in state ownership located on the territory controlled by Ukraine should be privatized. This goes in line with the decision to keep USPA in state ownership since the latter should not be managing ports and is responsible for port regulation and security.

In maritime transport there are two SOEs which do not have ownership policy: Maritime Search and Rescue Service and State Hydrography. 

The objective of Maritime Search and Rescue Service is “expedient rescue of people, provision of first aid services and evacuation to safe places.” This SOE also ensures that Ukraine complies with its international obligations with respect to maritime search and rescue. Respectively, to guarantee that Ukraine performs these obligations it is more efficient to do so through an SOE. 

State Hydrography SOE, just like the previous enterprise, has no ownership policy. Company mission consists of four elements that are to a different degree connected to ensuring navigation security. Similarly to Maritime Search and Rescue Service, the enterprise is performing international obligations of Ukraine. This SOE also creates maps. As mentioned above, security issues should lie within the authority of SOEs as private companies may refuse to provide such services and it may be impossible to find another company immediately. The state is also responsible under its international obligations so an SOE guarantees that they are enforced. 

Ukrainian Railways is a natural monopoly. Such market structure is sometimes regarded as justification for state ownership of the enterprise. Yet, with the absence of an independent regulator, which would ensure minimum social loses, there are no apparent benefits in having state ownership of natural monopoly. 

Under the circumstances of war, railways are also part of critical infrastructure that can ensure military needs. Still, this does not refer to rolling stock – locomotives and carriages. Rolling stock operators can easily compete between themselves. A model in which the state owns railways and different companies perform passenger and cargo carriage exists in many EU countries. A necessary pre-requisite for such model to work is equal access to railways. 

The number of private freight cars that Ukraine has is 19,000, while Ukrainian Railways owns 84,000 of freight cars. This means that the share of private cars is 18.5%. Ukrainian Railways are currently in the middle of negotiations with business regarding launch of private locomotives. Ownership policy of Ukrainian Railways has not been published yet (even though Ukrainian Railways is a “particularly important company for the economy” according to the definition of the Ministry of Economic Development and Trade). We believe the state needs to declare its intention to keep railway infrastructure in state ownership with gradual access of private carriers as it was done in the European Union. The model of the USA or Mexico when both the railways and transportation services belong to private companies is more risky for Ukraine as it will require a strong regulator which should do monitoring against collusion and abuse of monopolistic situation by network operators. Moreover, since Ukraine is in the middle of war, the state should have unlimited access to the whole transport network regardless of private owner. That is why state ownership of railways is justified. At the same time, the tariff for access of private operators to infrastructure should be economically reasonable and should foresee an investment component and the infrastructure operator (state) needs to ensure transparency of capital investment. 

The most mysterious out of the ten SOEs is Kyiv-Dnipro Inter-sectoral Enterprise of Industrial Railway Transport. Company web site says that is deals with “rail freight transportation between connecting stations and freight owners, maneuver works on access railways and loading areas, loading and unloading operations, maintenance and repairs of access railways and rolling stock.” 

In fact, the enterprise does not perform any function that a private company can’t. It is not providing public benefit and does not perform any security or regulatory function. Thus, privatization of this company could be the reasonable way out. 

The objective of Kyiv State Regional Technical Inspectorate for Electric Public Transport SOE is to conduct technical inspections and diagnostics of electric public transport, tramway tracks, contact networks and traction stations as well as registration and accounting of tramcars and trolleybuses for which no budget funding is foreseen in 35 cities. The company is in fact a controlling body which does quality checks of electric public transport. Overall, such services could be contracted from private companies, while registry of tramcars and trolleybuses for which no budget funding is foreseen could be assigned to local authorities. Consequently, the company can be terminated without damage to public interests.

The only SOE which does not belong to a specific infrastructure sector is Infrastructure Projects Funding. In mid 2018 company assets reached 13.6 bln UAH, 99% of which are circulating. 70% of circulating assets in 2018 were made up of receivables as well as money and its equivalents (another 29%). This means that the company almost does not own buildings or large production facilities. We have analyzed court decisions with respect to Infrastructure Projects Funding SOE to check whether the company was trying to collect receivables from counter parties. The largest sum of claim filed by the company is 550 million UAH, which makes up only 5.7% of the company’s receivables. Most claims are filed by Infrastructure Projects Funding against other state-owned enterprises. The above mentioned claim, for instance, was filed against Ukrainian Railways. There is also litigation involving Olimpiyskyi NSC, Arena Lviv SOE and others. It is no wonder, though, as the company was created for Euro 2012 and was working with sports facilities.

It remains to be decided how (and whether) the remaining receivables will be repaid. The enterprise reached settlement with Arena Lviv SOE. It is possible that they had similar agreements signed with other counter parties without involving the court. In 2017 net revenue from the sales of company products made up 51,000 UAH which shows that the activities of the company with extensive assets are virtually non-existent and the debt is not being repaid. The enterprise employs only 11 staff members. There is no ownership policy (even though it is supposed to be available pursuant to Key Principles) and it is not clear what the enterprise actually does. Media covered bonds issue before Euro 2012 as well as transfer of helicopter landing pad belonging to Yanukovych to the enterprise as custodian. In 2018 they conducted new procurements – predominantly with respect to equipment for transport junctions. Procurement in road sector conducted via this enterprise appears strange as Ukrroadinvest can also conduct such procurement with a lot less problems (see below). If the enterprise has no ownership policy in place, which would clearly state what the objectives of the enterprise are, then in view of the available capital assets, it should be wound up.

Ukrroadinvest SOE implements projects that are financed by international financial institutions, i.e. conducts procurement in the sphere of construction works and capital overhaul. The enterprise is actually doing procurement for Ukravtodor. According to State Information Agency interview with the director of the enterprise, Ukrroadinvest was created upon request of international organizations that are supporting infrastructure projects in Ukraine. A private company cannot dispose of state funds because of potential conflict of interest. That is why state ownership of Ukrroadinvest is justified.

Yet, it does not mean that the enterprise can do procurement only with the funds of international financial institutions. To optimize its activities, it would be feasible to transfer road sector procurement, which in the past year was done by Infrastructure Projects Funding SOE, to Ukrroadinvest.

Since the enterprise is in fact a procurement agency, just like Infrastructure Projects Funding SOE is, the risks involved with its activities are high. Under negligent management, the enterprise can turn into an institution without capital assets and a pile of hopeless debts from counter parties. Corporate governance of the enterprise should factor in these risks and the Supervisory Board should monitor them.

Conclusions

The state has finally paused to think why it owns companies. In the transport sector the answer has been provided with regard to Ukrposhta, Ukrainian State Air Traffic Services Enterprise and Ukrainian Sea Ports Authority by approving respective ownership policies. No ownership policies are yet available for Ukrainian Railways, Kyiv-Dnipro Inter-sectoral Enterprise of Industrial Railway Transport, State Hydrography, Maritime Search and Rescue Service, Ukrroadinvest and Infrastructure Projects Funding. 

We believe that some SOEs do not have clearly set objectives that would perform the social function. They need to be sold. Out of the infrastructure companies in particular, we can have Kyiv-Dnipro Inter-sectoral Enterprise of Industrial Railway Transport privatized. In view of the absence of their own funds, we suggest that Infrastructure Projects Funding SOE be wound up (after dealing with ongoing litigations). Ukrainian Railways need reforms so that provision of railway carriage services be demonopolized to a maximum degree. This issue may be explored within a separate article. We should also look for ways to attract a strategic investor (potentially a minority investor from micro financial organizations) for Ukrposhta.