Large And Small. The Path Of Privatization From Failure To Transparency

Ukrainian history of privatisation looks like a never-ending story of losses with only a few remarkable successes.

The major wave of mass privatisation in 1990s was executed by preferred share allocation and voucher privatisation mechanisms. It helped create a class of oligarchs rather than private owners and left a perception of unfairness among the population.

In October 2005, the largest Ukrainian steel mill Kryvorizhstal was re-privatised for a record amount of $ 4.8 billion at a starting price of $ 2 billion. However, it has been the most successful case yet. Although privatisation was taking place in the years to follow, it was mostly opaque and with limited competition.

Ukrtelecom, the largest state-owned enterprise (SOE) privatised in recent years, was sold for $ 1.3 billion in March 2011. The litigation is ongoing as the state is trying to take the company back due to the violation of investment obligations taken by the new owner.

Hope to change the situation came about after the Revolution of Dignity. The new government has called for accelerated reforms, including privatisation. However, despite the plans to attract UAH 17 billion to the budget from privatisation in 2014, that were then carried over year after year until 2018, the implementation of the budget revenue plan was a failure and ranged between 1 and 3% (Figure 1).

2017 was an outlier with privatisation revenues reaching UAH 3.4 billion. These revenues were almost wholly obtained from the sale of minority stakes in the five power distribution companies to the richest person in Ukraine Rinat Akhmetov who already owned the majority stakes in them.

Recent developments

The Revolution of Dignity of 2014 raised the expectations that more enterprises would be privatised as transparently as the Kryvorizhstal back in 2005. However, the major companies’ privatisation attempts have been blocked either by vested interests of the incumbent management or by the oligarchic lobby.

In 2016, the Ministry of Economic Development and Trade (MEDT) included 3445 enterprises in the triage list. So far, the number of enterprises in triage has decreased to 3243 (due to small-scale privatisation and liquidation), and its structure has changed.

In 2018, the “Basic Principlesz of Implementing Ownership Policies for Public Sector Entities” were adopted. According to these principles, SOEs with majority state ownership should develop ‘ownership policies’ defining the rationale for state ownership over these enterprises and their operational goals.

In March 2018, the new privatisation law came into force. It simplified the classification of assets to privatise (instead of 6 groups dividing them into just two – “large-scale” and “small-scale” privatisation with clear sets of procedures).

Small-scale privatisation proceeds via the state-owned Prozorro.Sale electronic bidding platform since August 2018. It can be named a success with 1 142 auctions that brought UAH 570 mln to the state budget and 910 mln to the local budgets over the first year of activity. As of now the share of successful auctions constitutes 40,9% of all auctions (due to the low number of bidders), and the majority (61%) of auctions were organizedby local councils rather than by the State Property Fund.

For the large-scale privatisation, the law enabled application of the English law to privatisation agreements and also allowed State Property Fund to attract professional investment advisors. Large-scale privatisation had been blocked in courts at different stages until recent positive developments (e.g. the claim for termination of the contract with the investment adviser for President-hotel was dismissed and bankruptcy proceedings for Centrenergo were closed). It might be connected with the recent political shift.

The two state-owned banks (SOBs) – Ukrgasbank and Privatbank – should be privatised by 2020 and 2022 respectively according to the government Strategy. The government also plans to sell 45% of Oshchadbank, of them 25% via an IPO. SOBs – both intended for privatisation and those remaining in the state ownership – have been introducing proper governance structures. The process is to be completed during the next year or so. Corporate governance reform is an important milestone in preparation of SOBs for the privatisation and private capital injection. Despite government plans, we argue for complete rather than partial privatisation of state-owned banks.

Policy problem and reform goals

Ukraine’s economy is held back by more than three thousand state-owned enterprises. The majority are inactive or loss-making. They are on average less profitable than private firms. They are also the major recipients of state aid in the form of recapitalisation and loans from the state-owned banks.

Furthermore, the SOEs are a source of corruption. In our view, the most effective way to deal with corruption is 100% privatisation of state-owned enterprises.

Privatisation is a possible way of attracting strategic foreign investments that can bring new production and management technologies to enterprises and increase their efficiency.

To facilitate privatisation, the following policies should be enacted:

• Active involvement of foreign investors into privatisation.
• Reducing the level of information asymmetry by involving independent investment advisers.
• Linking the system of financial and non-financial incentives (KPIs) of SOE top management to preparation of SOEs for privatisation – to prevent then from sabotaging privatization efforts.
• Priority privatisation of enterprises operating in competitive markets.
• Zero state share in privatised enterprises.

Potential future policies

The triage list from 2016 should be updated according to the newly created ownership policy legislative framework. It is necessary to repeal the Law “On the List of Objects of State Property that are not subject to privatisation” and at the same time dismiss the criteria for exclusion from privatisation described in the Law “On Privatisation of State and Communal Property”.

Instead, an expert commission of members of different parliamentary factions, the public, and international financial organizations should be set up to review draft ownership policies of all state-owned enterprises and define which ones should inevitably remain in the state ownership. The rest of enterprises should be privatised. SOE ownership policies should be subject to regular reviews which can reconsider the rationale for remaining in the state ownership.

Ownership policies can include plans for reorganization, partial or complete privatisation of the SOEs.

Enterprises ownership policy of which is approved must be transferred to the centralized institution for public property management*. This institution should implement state ownership policy and at the same time isolate state assets from the political influence and manage them for the benefit of the society.

According to the principles of ownership policy which should be implemented:

• The following should remain in state ownership: natural monopolies for which no special conditions for privatisation have been developed; those entities that are vital for the national security or carry out other socially important activities that cannot be fully fulfilled by private capital.
• OECD Principles of Corporate Governance and OECD Guidelines on Corporate Governance of State-Owned Enterprises should be applied in the management of the state-owned enterprises; in particular, supervisory boards should be established with a majority of independent members.
• Remaining enterprises should be privatised, transferred to a public-private partnership (in particular, concessions) or liquidated.

Equal rules of the game for private and public companies must be established. The state should neither create preferable conditions for SOEs nor complicate their business. Preferable conditions may include tax rebates, subsidies, special conditions on loans etc. Complications may result from additional unjustified bureaucratic and controlling procedures, limitations on asset management.