European Commission Recommendations on State-Owned Enterprises Management

In its latest report on Ukraine, the European Commission, despite the achievements and recommendations in the fight against corruption, touched upon the management of state-owned companies. 

Key events in this area and recommendations were not singled out separately, instead they were included in the section on the functioning of the market economy in Ukraine.

What the experts noticed

EC experts noted that the full-scale war increased the state’s influence on the economy. In 2022, the relative share of the public administration and defense sector jumped to 24% of GDP (in 2021 it was 7.2%), while the share of public spending more than doubled to 38.2% of GDP. The importance of many state-owned companies, such as Ukrzaliznytsia, Ukrposhta, or energy suppliers, has increased due to their crucial role in responding to the consequences of the full-scale invasion.

Despite the growing role of SOEs in certain areas of the economy, their overall efficiency remains at an extremely low level. According to the Ministry of Economy, as of the end of 2022, out of more than 3,000 state-owned companies, one in two is idle and only one in six is profitable. As a result, they completed the previous year with losses of UAH 91 bln. The heads of SOEs remain anti-leaders in the abuses uncovered by the National Anti-Corruption Bureau of Ukraine.

The problem of growth of the state’s share in the economy was also deepened by the use of mechanisms for the forced seizure and confiscation of Russian assets belonging to the aggressor or its supporters. Since September last year, the court has recovered shares or stakes in more than 50 enterprises, as a result of which they were effectively transferred to the management of the state. Since then, the only attempt to sell such assets failed. The State Property Fund, which manages confiscated assets, also complained about the transfer of enterprises to it without working capital, which shifts the obligations to repay their debts to employees and counterparties to the state. 

Therefore, the continuation of SOE corporate governance reform and privatization remain significant challenges for our economic policy, and we agree with this conclusion of the European Commission.

The EC experts assessed the results of small-scale privatization through Prozorro as quite successful(probably they were referring to Prozorro.Sale) before the full-scale invasion. 

The report also noted the adoption by the Parliament in July 2022 of the law on simplification of small-scale privatization procedures; TI Ukraine experts joined the improvement of its provisions. However, the European Commission was rather reserved in its assessment of the effect the resumption of privatization had: it noted that investors were interested in two ports, several distilleries, and other small real estate objects. 

But such an assessment is not entirely correct. After its resumption in September 2022, revenues from the privatization of state property for various periods (for example, for the first half of 2023, which includes the report) were record-high for the last 10 years. After the restoration, small-scale privatization brought UAH 4.6 bln to the national budget, contributed to the repayment of at least UAH 680 mln of SOE debts to employees and the budget, and private investors received ownership of 460 state property objects. Therefore, privatization after restoration is effective not only in terms of income, but also in terms of reducing the state’s share in the economy.

The report also drew attention to significant changes in the management of confiscated sanctioned (pro-)Russian assets. 

For a long time, the law did not give a clear answer as to who exercised such powers on a permanent basis, but instead gave the government the right to select a temporary manager of such assets among public authorities, military administrations, or state-owned enterprises. However, this approach proved ineffective, as the government delayed the adoption of relevant decisions. Some of the assets are still in limbo. The government has not been able to select a manager for Deripaska’s former assets for more than four months, even despite the SPFU’s appeal, and for more than seven months — in the case of the First Investment Bank of Russian oligarch Giner.

The Verkhovna Rada then adopted a law that assigned the functions of managing confiscated assets to the State Property Fund. But at the same time, the legislator put their implementation at risk, which was not mentioned in the EC report.

The European Commission also noted some progress in the reform of corporate governance of state-owned enterprises, which, however, still does not comply with the principles of the Organization for Economic Cooperation and Development to ensure depoliticized, professional, and transparent governance. The OECD Guidelines on Corporate Governance of State-Owned Enterprises is an internationally agreed standard for public administration bodies to ensure the effective functioning of state-owned enterprises in a market economy.

The factors that cause ineffective management of state-owned enterprises include:

–       the lack of an approved comprehensive national property policy;

–       corporatization of less than 10% of public sector business entities;

–       decentralization of ownership functions (more than 80 state bodies and departments manage state-owned enterprises);

–       the limited role of supervisory boards and the nominal independence of their members.

Recommendations of the European Commission

In the report, the EC experts provided two recommendations to Ukraine in the field of management of state-owned enterprises.  

The first one is to improve SOE management in line with OECD recommendations.

After the full-scale invasion alone, the government transferred 2,200 state-owned enterprises to the State Property Fund. Thus, it concentrated more than 70% of all business entities of the public sector of the economy in the management of the body. The SPFU has already conducted a triage of the SOE portfolio and determined the list of enterprises that can be put up for sale, will not be subject to privatization, or should be liquidated by the decision of the Fund itself or in bankruptcy. 

The creation of a centralized body to perform the functions of the SOE owner is designed to increase their efficiency through the application of a unified approach to management and the delineation of the functions of the owner, the policy-making entity, and the regulator among the authorities. The OECD Guidelines on Corporate Governance of State-Owned Enterprises provide for the application of such an approach. 

This partially echoes the idea of creating a sovereign fund for the SPFU to unite all strategic assets of the country that will not be subject to privatization. But establishing a sovereign fund will not change anything because it is the quality of its asset management that will play a decisive role. There are things that need to be improved before the launch of this fund — to implement the principles of corporate governance of the OECD, in particular to enhance the role of supervisory boards in the management of enterprises (granting exclusive powers to appoint managers, approving strategies and financial plans) and the introduction of mandatory elements of the internal control system(compliance, risk management, internal audit). This will reduce the political impact on the operational activities of state-owned companies and, accordingly, reduce corruption risks. The necessary changes are reflected in the draft law, which is being prepared for consideration by the parliament in the second reading. 

It is also important to improve and resume the procedures for the competitive selection of managers, heads of executive bodies, and members of supervisory boards of public sector business entities (except for a number of the largest companies), which the government canceled at the end of May last year.

Another recommendation of the European Commission is to intensify privatization processes.

In 2023, the SPFU managed to attract more than UAH 2.7 bln from the sale of 320 small-scale privatization objects to the national budget. However, this is less than half of the planned income because UAH 6 bln of revenues from the sale of state property was provided for in the national budget for this year. Therefore, the State Property Fund has set a goal to put up for sale another 188 objects by the end of the year with a starting price of UAH 1.36 bln. 

The government and, in particular, the Ministry of Economy play a significant role in accelerating the process of transferring state-owned enterprises to the State Property Fund for privatization. Recently, the Cabinet of Ministers has reduced the list of documents that loss-making SOEs provide to formalize their transfer to the Fund’s management for further sale. Now another 103 state-owned companies can be privatized. 

Despite the fact that at the end of May the parliament removed legislative obstacles, and the government settled technical issues for the launch of online auctions for large-scale privatization in July, the State Property Fund was never able to offer private investors any large state assets. Recently, the SPFU initiated before the government the inclusion of the share in the Ocean Plaza shopping mall confiscated from the Russian oligarch Rotenberg in the list of objects of large-scale privatization. The company can be put up for sale alongside with Odesa Portside Plant, Centrenergo, and the UMCC.

But in addition to large objects, the SPFU already manages enough of other sanctioned assets. After an unsuccessful first attempt, the agency has already announced the next asset for privatization, but we expect that this will be preceded by amendments to the legislation that restricts the SPFU in the sale of recovered assets.

How to implement these recommendations

Ukraine has demonstrated some progress in the management of state-owned enterprises, which the experts noted and reflected in the report of the European Commission. After the beginning of the full-scale invasion, the course for privatization continues, and corporate governance reform is on the verge of a new stage of its development.

As for the recommendations provided, they are quite generalized and do not contain clear steps for their implementation. But without a doubt, compliance with them is necessary and will be assessed in the light of the recommendations to open negotiations with Ukraine on accession to the EU.

It is important to mention that these recommendations are reflected and actually clarified in one of the key documents of our anti-corruption policy — the State Anti-Corruption Program. 

Analyzing the State Anti-Corruption Program, we noted that it contained a list of important and necessary steps towards reducing corruption in the field of public property management. Since the European Commission emphasizes the timely and steady implementation of the State Anti-Corruption Program, we expect that this will become an additional impetus in continuing reforms in this area.

This publication was prepared by Transparency International Ukraine with the financial support of Sweden.