Report No. 59950-UA UKRAINE SYSTEM OF FINANCIAL OVERSIGHT AND GOVERNANCE OF STATE-OWNED ENTERPRISES February 22, 2011 Operations Policy and Services Department Europe and Central Asia Region Document of the World Bank CURRENCY EQUIVALENTS Ukraine Hryvnia (UAH) February 2011: USD1 = UAH 7.95 FISCAL YEAR (January 1 to December 31) ACRONYMS AND ABBREVIATIONS CCU Commercial Code of Ukraine MOF Ministry of Finance CMU Cabinet of Ministers of Ukraine NAS National Accounting Standards EC European Commission OECD Organization for Economic Cooperation and EU European Union Development FDI Foreign Direct Investment PIFC Public Internal Finance Control GDP Gross Domestic Product ROSC Report on the Observance of Standards and Codes IFC International Finance Corporation SAI Supreme Audit Institution IFRS International Financial Reporting Standards SBA Stand-By Agreement IMF International Monetary Fund SCI Statement of Corporate Intent ISA International Standards on Auditing SOE State-Owned Enterprise JSC Joint-Stock Company SPF State Property Fund KRU State Control and Revision Service WB The World Bank MOE Ministry of Economy Vice President: Philippe H. Le Houerou Country Director: Martin Raiser Sector Director: Gerard A. Byam Sector Manager: Ahmadou Moustapha Ndiaye Task Team Leader: Rajeev Swami TABLE OF CONTENTS EXECUTIVE SUMMARY .................................................................................................................... i SECTION I: INTRODUCTION ............................................................................................................ 1 Key Development Issues and Rationale for Bank Involvement ................................................. 3 Objective ..................................................................................................................................... 5 Methodology ............................................................................................................................... 5 SECTION II: BASIC ELEMENTS OF THE SOE SECTOR IN UKRAINE .............................................. 7 Context of State-Owned Enterprises in Ukraine ......................................................................... 7 Statistics and Performance of the SOE Sector ............................................................................ 9 Legal Framework for SOE Oversight ....................................................................................... 10 The State Ownership Function.................................................................................................. 12 Transparency and Disclosure .................................................................................................... 18 SECTION III: ASSESSMENT OF UKRAINE’S SYSTEM OF SOE OVERSIGHT ................................. 20 Legal Framework for SOE Oversight ....................................................................................... 20 The State Ownership Function.................................................................................................. 21 Transparency and Disclosure .................................................................................................... 32 SECTION IV: BENCHMARKING UKRAINE AGAINST THE OECD FRAMEWORK .......................... 37 Good International Practice with regard to SOE Legal and Regulatory Frameworks .............. 37 Evolution of the State Ownership Function .............................................................................. 40 Transparency and Disclosure .................................................................................................... 44 CONCLUSIONS AND RECOMMENDATIONS .................................................................................... 48 ANNEX 1: SOE LEGAL FRAMEWORK AND REGULATIONS ........................................................ 53 ANNEX 2: MINISTERIAL SOE PORTFOLIOS ................................................................................ 58 ANNEX 3: EXTRACT FROM THE OECD GUIDELINES ................................................................. 62 ANNEX 4: BENCHMARKING UKRAINE AGAINST THE OECD FRAMEWORK ............................. 64 ANNEX 5: BIBLIOGRAPHY ........................................................................................................... 74 ANNEX 6: CORPORATE GOVERNANCE LANDSCAPE QUESTIONNAIRE ....................................... 77 ANNEX 7: ASSESSMENT QUESTIONNAIRE FOR FINANCIAL OVERSIGHT OF SOES .................... 82 BOXES, FIGURES AND TABLES TABLE 1: MAIN MACROECONOMIC INDICATORS FOR UKRAINE, 2001-2008 .............................. 2 TABLE 2: COMMON REFORM AREAS IN GOVERNMENT PROGRAMS 2000-2008.......................... 8 TABLE 3: BASIC DATA ON THE SOE SECTOR IN UKRAINE ........................................................... 9 FIGURE 1: SOE GOVERNANCE SYSTEM IN UKRAINE ................................................................. 13 TABLE 4: RESPONSIBILITIES OF THE CABINET OF MINISTERS IN THE OVERSIGHT OF SOES ... 14 TABLE 5: SOE OVERSIGHT ROLES OF LINE MINISTRIES AND AGENCIES ................................. 15 TABLE 6: RESPONSIBILITIES OF THE STATE PROPERTY FUND IN THE OVERSIGHT OF SOES ... 16 BOX 1: PERFORMANCE ASSESSMENT CRITERIA FOR UNITARY AND KAZENNI SOES ............... 23 BOX 2: PERFORMANCE ASSESSMENT CRITERIA FOR JOINT-STOCK COMPANIES ..................... 24 BOX 3: KRU REPORT ON THE INSPECTION OF STATE JSC KHLIB UKRAINY, JUNE 2009 ........ 30 BOX 4: ACCOUNTING CHAMBER INSPECTION OF NAFTOGAZ (2006-2008) ............................... 31 TABLE 7: MAIN FINANCIAL INDICATORS OF SOES, 2007-2008 ................................................. 32 BOX 5: SEQUENCING OF REFORMS ............................................................................................. 52 ACKNOWLEDGEMENTS The team is gratefully acknowledges the extensive cooperation and assistance from officials from the Government of Ukraine. In particular, the Bank team would like to recognize the leadership exercised by the Ministry of Economy in coordinating the collaboration and input of senior officials from relevant ministries and agencies, including the Ministry of Finance, the State Property Fund, the Central Control and Revision Unit. The team also would like to acknowledge the collaboration from officials, directors and managers from several state-owned enterprises, and state-owned government agencies. This report was prepared by a team led by Rajeev Swami (Sr. Financial Management Specialist), Oleksiy Balabushko (Public Sector Specialist), and Konstantin Shkurupiy (consultant). The team benefited from the guidance and advice of Martin Raiser (Country Director, ECCU2) and Ahmadou Moustapha Ndiaye (Sector Manager, ECA Financial Management). This report also benefited from comments made in informal discussions, including comments received at several review stages, from several World Bank and IFC colleagues including Alexandre Arrobbio (peer reviewer), Henri Fortin (peer reviewer), Pablo Saavedra, Roman Zyla and Marius Vismantas. Executive Summary EXECUTIVE SUMMARY i. State-owned enterprises (SOEs) continue to represent a significant share of Ukraine’s economy, and play a dominant role in sectors such as rail, transport, utilities, energy and telecommunications. These enterprises play an important role for the government by remitting dividend payments to the national treasury to fund the country’s development agenda. At the same time, these same enterprises receive fiscal support from the government – through a transfer of budgetary resources, issuance of guarantees for enterprise debt, facilitation to lines of credit and other financial instruments, etc. ii. While Ukraine’s large structural fiscal deficits were masked during the growth years of 2004-2008, public and publicly guaranteed debt levels are growing. The current weak fiscal position and tightening budget constraints will require government action to improve the performance and profitability of the overall SOE sector, as it is significant driver of the country’s economic output. As the global economic crisis has hit Ukraine particularly hard, there is a pressing need to rationalize and improve the allocation of fiscal resources in order to stabilize the economy and to resume industrial production and growth. iii. The continued presence of SOEs combined with both a slowdown in privatization as a result of the financial crisis and the reassertion of the state through temporary takeovers or outright nationalization of companies has brought SOE corporate governance squarely on to the reform agenda. This report is not an assessment of performance of individual SOEs. Rather, it focused on the current system of SOE oversight as a whole with an objective to identify areas of weakness and to propose measures to align Ukraine’s systems and practices with international benchmarks, standards and good practice. iv. Summary of Findings. Ukraine’s SOE sector has a wide range of ownership and management schemes. The basic legal framework for SOE oversight, defined in the Commercial Code of Ukraine, provides for the delegation of responsibilities across several ministries/agencies. As a result, there are overlapping roles across different government institutions, and gaps with regard to active monitoring and oversight. v. In practice, the SOE oversight function of the line ministries is primarily exercised through a review of the reports submitted by the SOEs on the implementation of financial plans. However, the review is typically light, and its efficiency is undermined by the limited clarity of the operating objectives for SOEs, and limited usefulness of the performance management framework. Moreover, the underlying data used to measure performance indicators is not validated and its reliability is uncertain. Even though the current performance management framework can be improved, performance evaluations are not conducted for a substantial number of SOEs which seriously undermines the effectiveness of oversight. i Executive Summary vi. Transparency and disclosure requirements are in need of significant strengthening and should first be clearly established in a modern legal framework. Many of the deficiencies in Ukraine’s current financial reporting architecture, in particular incomplete consolidations and the absence of appropriate or complete disclosures relating to related parties and owners, make it difficult for users to make a proper assessment of the financial position and performance of an SOE. There is no requirement for entities to be subject to an annual external audit. Additionally, SOEs are not required to disclose or publish basic financial information, corporate results, or other non-sensitive company information. There is also a need to enforce the proper application of transparency and disclosure policies and ensure that public access to information is guaranteed. vii. In attempting to strengthen its system of oversight and in order to improve the performance of the SOE sector, there are three basic issues, which once resolved, would enable the government to better target its reform initiatives. First there is an urgent need to establish a single and comprehensive database of all SOEs operating in Ukraine. The lack of complete and thorough information is representative of some of the weaknesses identified in the current system of management and oversight. Second, in order to focus attention and efforts to improve the performance of those enterprises which represent either significant value to the economy (or to a specific sector) or which represent significant risk (e.g., fiscal risk), it would be important to segment the sector – distinguishing large SOEs from small and medium enterprises. Third, all large SOEs should be subject to process that utilizes the principles of corporatization with a clear purpose to improve the enterprise’s internal management structures. This effort would also include establishing independent, professional and competent boards of directors (which will assume the responsibility for primary oversight of the enterprise), strengthening internal controls, and modernizing (or implementing) operational and risk management systems and practices. viii. Looking forward, the detailed recommendations below focus on three interrelated and critical areas which underpin any effort to reform or improve SOE performance: (i) legal framework, (ii) state ownership policy, and (iii) transparency and disclosure. A strong legal framework not only requires the implementation of modern corporate governance practices within an enterprise, but it also supports the development of clear objectives and goals against which performance can be objectively measured. In trying to improve the performance of SOEs, it is also necessary to ensure that these enterprises are insulated from political interference, to clarify the government’s oversight and monitoring role, and to establish an arms-length relationship between government and SOEs in terms of managing an enterprise’s operations. Lastly, transparency is the cornerstone of any governance reform and open access to information provides the basis for accountability and enhances the ability to assess performance and allocate capital and resources effectively. ix. Legal Framework. The legal framework for unitary and kazenni SOEs is in need of modernization and upgrading. In revising the legal framework for SOEs, it is desirable to establish a single, unifying and basic set of regulations which would be applied evenly across all sectors. This effort should strive to reduce, or eliminate ii Executive Summary entirely, the current differences between regulations applicable to joint-stock companies and those which apply to unitary and kazenni enterprises. It is also important to simultaneously better define what the role of government oversight entails as well as clarify the government ministry/agency which is responsible for a specific function. It is essential that the legal framework establish a clear arms-length relationship between government and an SOE and should include specific limits on the government’s role or influence regarding an SOE’s access to finance and credit. Modern corporate governance practices (including establishing independent and professional boards of directors, including board committees for all large SOEs) should be integrated into the revised and upgraded framework. Lastly, the legal framework should require that SOEs establish clear operating objectives as this would strengthen the performance management framework and in turn, help focus efforts on those enterprises which require restructuring or additional forms of assistance. x. State Ownership Policy. In formulating the state’s ownership function, which should be underpinned by a strong corporate governance framework, the government of Ukraine should first develop a clear ownership policy which separates the regulatory function from management and oversight, and which provides the general public with a clear understanding of the state’s objective as an owner. In attempting to strengthen accountability, the government, as the ultimate guarantor of SOE debt and liabilities, should develop clear limits with regard to its financial obligations and exposure. There should also be clear criteria which would help evaluate SOE proposals or requests to access financial instruments. xi. While Ukraine has implemented a performance management framework, there is a need to improve both the quality of indicators as well as the quality of information used for measurement. As there are significant gaps in compliance with performance evaluations and even with remittance of dividends to the national treasury, it will be important to develop mechanisms by which to enforce compliance with these requirements. xii. Transparency and Disclosure. The transparency framework and basic accountability requirements and practices for all SOEs can be strengthened. SOEs should be required to ex-ante publicly disclose/publish the enterprise’s operating objectives (commercial and non-commercial objectives) as well as financial plans. It will be important that the transparency framework establish the requirement for public disclosure of the annual reports on SOE performance – both in aggregate as well as for individual enterprises. xiii. Although there are some material differences between International Financial Reporting Standards (IFRS) and Ukrainian National Accounting Standards (NAS), large SOEs (with primarily commercially oriented operations) should be required to fully comply with National Accounting Standards in preparing their annual financial statements. The MOF has recently taken several steps to upgrade NAS and to eliminate the remaining differences with IFRS. The introduction of IFRS should remain a medium to longer term goal as it would align Ukraine with international practices. Large SOEs iii Executive Summary should also be required to report comprehensively, including consolidation of financial information for its subsidiaries. Upgrading the underlying standards of financial reporting would also significantly help improve the reliability and usefulness of data used for performance measurement. The draft Law on Accounting can be broadened to also include this category of SOEs in the application of IFRS as the international standard will be implemented over time. xiv. In aligning with international good practice, the transparency and accountability framework would require that all large SOEs (whose operations are commercially oriented) have their financial statements audited by statutory auditors in accordance with International Standards on Auditing – and all SOEs should be subject to some form of independent annual financial audit. The audit requirement would also help to ensure that company financial data and results, which are used for performance measurement, is validated and reliable. The current draft Law on Auditing can be amended to incorporate this category of SOEs within its mandate. xv. Finally, it is important that all SOEs, especially the large SOEs, be required, ex- post, to publish (at a minimum) their annual reports and audited financial statements in a timely manner. There is a need to significantly strengthen and enforce compliance with the Law on Information to ensure that the general public, including interested users of financial information, has unrestricted access to company information that is not determined to be commercially sensitive. iv Introduction SECTION I: INTRODUCTION1 1. Ukraine has a vibrant democracy but faces severe governance weaknesses that are at the root of many reform challenges in the country. In February 2010 a new President was democratically elected, the second time free and fair elections were held since 2005. The media is lively and civil society is vibrant if disorganized. However, the accountability of public officials remains low and the elite often rule with impunity. Moreover, frequent elections and contradictions in the constitution have led to political volatility and diverted the attention of leadership away from burning economic and social challenges. Ownership of the governance agenda has been limited due to strong vested interests within government and key business groups. Poor governance has caused deep discontent with state performance, lack of trust in government, and low social mobilization for governance building initiatives. 2. Ukraine was an average growth performer in a fast growing region between 2000 and 2008. Since the economy bottomed out in 1999 following the Russian crisis, real GDP growth averaged 7 percent between 2000 and 2008 (see table 1), just above the Europe and Central Asia (ECA) region’s2 average of 6.4 percent, but below the group of countries in the Commonwealth of Independent States (CIS) that averaged 7.5 percent.3 Growth performance appears to be less impressive, however, taking into account the low base caused by the deep and protracted economic contraction of Ukraine in the 1990s. Therefore, Ukraine had been growing with the region, but not significantly converging toward the new EU countries levels of income. 1 World Bank’s Country Partnership Strategy Progress Report for Ukraine (2010) and the 2010 Country Economic Memorandum (forthcoming). 2 The ECA region includes the following countries: Albania ,Armenia, Azerbaijan, Belarus, Bosnia & Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kosovo, Kyrgyz Republic, Latvia, Lithuania, FYR Macedonia, Moldova, Montenegro, Poland, Romania, Russian Federation, Serbia, Slovak Republic, Slovenia, Tajikistan, Turkey, Turkmenistan, Ukraine, Uzbekistan 3 The CIS include most of the former Soviet Union republics, except for the Baltic countries. 1 Introduction TABLE 1: MAIN MACROECONOMIC INDICATORS FOR UKRAINE, 2001-2008 2001 2002 2003 2004 2005 2006 2007 2008 Real GDP (change in percent) 9.2 5.2 9.6 12.1 2.7 7.3 7.9 2.1 Real Industrial Production (change in percent) 14.2 7.0 15.8 12.5 3.1 6.2 10.2 -3.1 CPI, a.o.p. (change in percent) 12.0 0.8 5.2 9.0 13.5 9.1 12.8 25.2 CPI, e.o.p. (change in percent) 6.1 -0.6 8.2 12.3 10.3 11.6 16.6 22.3 Real Exchange Rate, a.o.p. (change in percent, a decline means depreciation) 11.2 -3.7 -8.2 -2.1 10.2 4.8 1.4 9.3 Current Account Balance (percent of GDP) 3.7 7.5 5.8 10.6 2.9 -1.5 -3.7 -7.2 Foreign Exchange Reserves (USD billions) 3.1 4.4 6.9 9.7 19.4 22.4 32.5 31.5 Net FDI (USD billions) 0.8 0.7 1.4 1.7 7.5 5.7 9.2 9.7 Fiscal Balance (percent of GDP) -1.6 0.5 -0.9 -4.4 -2.3 -1.4 -2.0 -3.2 Public and Publicly Guaranteed Debt (percent of GDP) 38.6 36.5 29.0 24.7 17.7 14.8 12.4 20.1 Memo: Nominal GDP (in billions of USD) 38.0 42.4 50.1 64.9 86.2 107.8 142.7 180.2 GNI per capita (USD, Atlas method) 720 780 970 1260 1520 1960 2560 3140 Sources: SSC; NBU; IMF; WB staff calculations. 3. Large structural fiscal deficits were masked by rapid growth since 2004. Cash fiscal deficits during 2001-2008 averaged 1.9 percent GDP but in 2009, the general government fiscal deficit on cash basis was 8.8 percent of GDP (including Naftogaz but not including the costs of bank recapitalization).4 While the headline deficits during 2001 and 2008 looked moderate, the underlying structural balances were much worse. This has been sharply revealed as a result of the crisis. The public and publicly guaranteed debt level is growing and needs to be stabilized and reduced over time. The current weak fiscal position and the lack of up-front action to rein in the deficit will significantly increase debt. Without corrective measures this may have unintended consequences on the costs of external financing as capital markets become more selective. There is thus a significant risk of crowding out private investments by raising the cost of finance both domestically and externally. 4. As the crisis unfolded Ukraine’s economy contracted by 15 percent in 2009, exposing its underlying macroeconomic and structural vulnerabilities. These included: (i) a weak maturity structure of the fast growing private sector external debt; (ii) banking sector vulnerabilities associated with the rapid loan growth supported by predominantly external funding and weak regulatory and supervision controls; (iii) volatile terms of trade and lack of diversification in external demand (mainly related to the steel and heavy industry sectors on the export side and the gas sector on the import side), (iv) expansionary fiscal policies in the context of problematic expenditure and revenue structures; (v) weak competition and ability to diversify and generate higher value added products; and (vi) an overall burdensome regulatory environment and large government footprint that hamper private sector development 4 The costs of bank recapitalization amounted to 2.3 percent of GDP. They were agreed as part of a below the line adjuster under the IMF’s SBA. 2 Introduction 5. To close the gap with its eastern European peers and neighbors and achieve sustained fast economic growth, Ukraine thus needs to accelerate and deepen structural reforms. Ukraine will have to improve its business climate, increase export sophistication and diversification, and build up its physical and social infrastructure. As fiscal pressures continue to mount, rationalization and improved allocation of fiscal spending has become a priority. Strengthening banking sector regulation and supervision will be critical to safeguarding financial stability and ensuring a sustainable recovery. Improved SOE governance and management has linkages to several key reform fronts: (i) it can help safeguard scarce fiscal resources, (ii) it can help create a level playing field and improve competition in the private sector, and (iii) it can help provide cheaper, better quality and more efficient public services in areas where the state continues to have a role to play as an owner (and sometimes as an operator) or key public infrastructure. 6. The continued presence of SOEs combined with both a slowdown in privatization as a result of the financial crisis and the reassertion of the state through temporary takeovers or outright nationalization of companies has brought SOE corporate governance squarely on to the reform agenda.5 A long history with SOE reform shows that significant corporate governance challenges contribute to poor SOE performance. Driven by a wide separation of ownership (by the citizens of a country) from control (by the directors and managers that run the company), SOEs are frequently governed by multiple government bodies (one or more ministries, cabinet, a dedicated ownership entity, Parliament), each using the companies to achieve short-term goals. SOEs are also characterized by weak legal and regulatory frameworks, unclear or conflicting objectives (an ineffective ownership function), lack of transparency and accountability and weak boards of directors. Together, these factors undermine SOE efficiency and service delivery, impact the use of public funds, and open the door to corruption. As such, the unfinished reform program to restructure and modernize the system of SOE governance will be of critical importance to the agenda of the new administration. KEY DEVELOPMENT ISSUES AND RATIONALE FOR BANK INVOLVEMENT 7. The World Bank had commissioned two separate studies (the 2002 “Study on Management of State-Owned Enterprises in Ukraine� and the 2007 “Analysis of Performance of State-Owned Enterprises�). While both studies analyzed the full range of SOEs (Unitary, Corporatized and Joint-Stock Companies), they have provided a complete background and overview into the structural limitations of current management responsibilities. The 2002 study in particular noted a series of cross-cutting weaknesses including the lack of enforcement of state corporate law, significant gaps in state corporate principles and actual practice, lack of a single government agency with responsibility for oversight, significant gaps in financial reporting – which is 5 Concept Paper: Toolkit for Improving SOE Corporate Governance (2010). See also the 2010-2014 Reform Program prepared under the auspices of the Economic Reform Council. 3 Introduction simultaneously incomplete and repetitive - and weak ministerial management and surveillance.6 8. SOEs have a varying degree of managerial independence—relatively low where the state has majority ownership.7 Most types of enterprises fail the test for managerial independence based on one or more of the following elements: • Under pricing is widespread. The kazenni SOEs have been designed to supply goods and services to the state below cost. Ordinary SOEs and key holding companies also tend to under price, particularly in ‘sensitive’ sectors, such as energy and household services. As an example, cost recovery rates for water supplied via communal enterprises ranged from 60 to 90 percent in 2003. • Employment policies are not fully in line with market practices. Wage setting is based on labor union agreements for kazenni and unitary SOEs. More independence is given to those companies where government control is looser, but even for these the government has recently imposed restrictions on wages paid. • The commercial orientation of Ukrainian SOEs is weak. Many of the largest companies (including in the energy sector) hold the majority of their market or operate as monopolies. A large fraction of their turnover may be highly reliant on sales to the state and local governments. Studies suggest that managers have little or no experience in defining market-oriented policies, especially at the local level, for instance, the communal service providers. 9. Additionally, the International Finance Corporation (IFC) had commissioned a comprehensive study on corporate governance practices in Ukraine. The 2008 study had two inter-related objectives: (i) to explore the level of development of internal audit practices and internal control systems in Ukrainian companies and banks and (ii) to estimate the attitude of investors in Ukraine about the internal audit function and internal control systems in companies and banks in Ukraine. While the focus of the IFC work was to evaluate the private sector, the study revealed that the internal audit function is not a common component of the overall internal control system/framework in Ukrainian companies and even where internal audit was found to exist, the department’s independence from management was in question. The more startling result was the attitude of investors. Approximately half of the investors surveyed agreed that adequate internal controls and a functioning internal audit department reduced investment risk. About 84% of the investors responded that they were not satisfied with the information (lack of) concerning internal controls being disclosed by companies – a majority indicated this should be included in a company’s annual report. Finally, over 50% of the investors surveyed indicated that investments were not made because of inadequate 6 While the 2002 study reported an extensive number of systemic and cross-cutting weaknesses, for the purposes of this study, the most relevant weaknesses have been included. For a full list, please see the 2002 report annex 5 “Problematic Areas for State-Owned Enterprises.� 7 Leonov and Stetsenko (2007) and the IMF Country Report No. 07/47 4 Introduction internal controls and internal audit or where improvements in these areas were required as a pre-condition for the investment. 10. It is evident that the awareness of and culture to put into practice modern oversight systems has not yet matured in Ukraine. Where the private sector enterprises have inherent incentives to modernize or to align with accepted international practices in order to attract private capital and investment, the public sector has no such inherent incentives. The results from the IFC study underscore the importance to evaluate the degree to which public sector enterprises, SOEs, are effectively monitored and supervised, and implement modern corporate government practices. OBJECTIVE 11. The overall objective of this study is to analyze the current system of SOE oversight and propose measures to bring Ukraine’s systems and practices to the level of international good practice. The study attempts to achieve this objective by reviewing the performance and current functions of governmental bodies responsible for oversight and through a comparative analysis of Ukraine’s systems of oversight with other developed and emerging market economies. In doing so, the study supports the Government of Ukraine’s efforts to improve the level of transparency, efficiency and effectiveness in the management and oversight of SOEs. 12. The study complements rather than duplicates previous analytical work. This study has updated the analysis of the 2002 commissioned study which identified general weaknesses in how SOEs are effectively monitored and supervised but did not put forth concrete policy recommendations. Additionally, this study responds to the IFC study by evaluating the practices of SOEs with regard to transparency and disclosure, and evaluating the degree to which these practices align with international norms and standards. With regard to SOE practices, the study further examined the degree to which these practices, as they relate to the OECD Guidelines for Corporate governance of State- Owned Enterprises, are aligned with international best practice. METHODOLOGY 13. This study analyzed the current arrangements for financial oversight in SOEs and the role of government units in exercising this function. The study reviewed the functions and practices of central government ministries (Ministry of Economy, Ministry of Finance, and line ministries). Given the size of the SOE in Ukraine, the study focused on the overall system of oversight and governance rather than analyze practices at the enterprise level. This study did not address related topics such as the roles and functions of SOE Boards of Directors or Securities Market regulations as these areas merit their own in-depth reviews. This report also analyzed the tools of and actions the State Property Fund takes with respect to exercising its oversight role for Joint-Stock Companies. While the assessment of the State Property Fund was not a direct objective of this work, it was nevertheless an important component in assessing the quality of the central government’s oversight arrangements for SOEs. 5 Introduction 14. In reviewing the oversight arrangements for SOEs, it was necessary to focus the scope of this work on the legal and regulatory framework, the ownership policy and state functions of ownership and transparency and disclosure policies. A strong legal framework not only requires the implementation of modern corporate governance practices within an enterprise, but it also supports the development of clear objectives and goals against which performance can be objectively measured. In trying to improve the performance of SOEs, it is also necessary to ensure that that the government has established a clear ownership policy which insulates SOEs from political interference, clarifies the government’s oversight and monitoring role, and establishes an arms-length relationship between government and SOEs in terms of managing an enterprise’s. Lastly, transparency is the cornerstone of any governance reform and open access to information provides the underlying basis for accountability/oversight and enhances the ability to assess performance and allocate capital and resources effectively. While these three areas may appear to be distinct, they are in fact closely intertwined and are the foundations of any attempt to improve the performance of SOEs. The questionnaires used as one of the primary means to collect information can be found in annexes 6 and 7. 15. Additionally, the 2005 OECD Guidelines on Corporate Governance of State- Owned Enterprises have been used as a benchmark against which Ukraine’s system of financial oversight can be evaluated. This paper also includes an analysis of how the current system in Ukraine measures against relevant examples from OECD member where the use of performance monitoring indicators is one component of the broader oversight system. The recent OECD Survey of Corporate Governance practices (Chapter 1, Ensuring an Effective and Regulatory Framework for State-Owned Enterprises, Chapter 2, Organization of the Ownership Function within the State Administration and Chapter 5, Transparency and Disclosure – see Annex 3 for details on the OECD code) in member countries also offers useful country case studies which have been used to measure the effectiveness of the practices in Ukraine. Additional research is included as to provide additional country cases/comparisons – in particular, seeking examples from industrialized or similar emerging market economies. 16. The structure of this paper is as follows: • Section 1 – Introduction, including objectives and scope of the study • Section 2 – Basic elements of the SOE sector in Ukraine • Section 3 – Assessment of Ukraine’s system of SOE oversight • Section 4 – Benchmarking Ukraine against the OECD Guidelines and good international practice • Conclusions and Recommendations • Annexes 6 Basic Elements of the SOE Sector in Ukraine SECTION II: BASIC ELEMENTS OF THE SOE SECTOR IN UKRAINE CONTEXT OF STATE-OWNED ENTERPRISES IN UKRAINE 17. Ukraine has made progress during the transition to a market-oriented economy but major challenges still remain. Large-scale privatization, enterprise restructuring, and implementation of modern governance frameworks still remain largely incomplete.8 In 1998/9 Ukraine shifted from large-scale privatization to case-by-case privatization. By 2001, the government had recouped 1.3 percent of GDP in privatization receipts. The IMF found that through 2000, Ukraine’s cumulative receipts resulting from privatization was about 3 percent of GDP, compared to an average for all transition economies during the same period of 9 percent.9 While progress was noted in that the privatization process was more transparent than before, the process was still plagued with problems, including political interference. Often the government only sold a minority share in enterprises that had been put up for bidding. Widespread collusion amongst bidders was a frequent deterrent to attract non-CIS interest and managers of enterprises claimed control through front companies initiating bids.10 18. Despite previous efforts to privatize numerous state managed and controlled operations, the government still maintains a considerable share of the economy. Though acknowledging that reliable data has been difficult to obtain, IMF and Bank staffs have estimated that SOEs currently represent approximately 22-25% of GDP. Previous analytical work has identified the oversight of SOEs as a critical issue.11 Specifically, the issue of transparency in the management and oversight of SOEs has been a central concern over the past several years. 19. Successive governments have recognized the need to reform the SOE sector. During the period 2001-2006 the government had established several working and policy analysis groups which have proposed a series of recommendations to improving government ownership and management over the SOE sector. In 2006, the State Agency for Investment and Innovation of Ukraine prepared a White Paper12 which identified several issues and problems in attracting foreign investment to Ukraine, including the issue of corporate governance and oversight/management of state-owned enterprises. The working group, which included a number of high ranking officials (at the levels of deputy minister) from the Ministry of Economy, Finance, Cabinet of Ministers etc., recommended a series of related policy initiatives including: (i) gradual harmonization of the corporate governance legal and regulatory 8 Ibid. 9 IMF Policy Discussion Paper, “Privatization in Ukraine: Challenges of Assessment and Coverage of Fund Conditionality.� PDP/02/7 10 Ibid. 11 Ukraine – Improving Inter-governmental fiscal relations and public health and education expenditure policy (2008 Report No. 42450-UA); Public Financial Management Performance Report (2007 Report No. 39015-UA); Creating Fiscal Space for Growth (2006 Report No. 36671-UA). 12 Attracting Foreign Investment to Ukraine: Problems and Solutions (2006), State Agency for Investment and Innovation of Ukraine (Main Department of the Civil Service of Ukraine) and the International Centre for Policy Studies 7 Basic Elements of the SOE Sector in Ukraine framework with European Union (EU) legislation; (ii) identifying and separating the functions of state ownership rights and functions for SOEs; (iii) implementing strengthened corporate governance rules and practices in the public corporate sector. 20. The previous government moved rapidly to present its “Ukrainian Breakthrough� program to the public, but the program did not manage to obtain full endorsement by Parliament. As Table 2 below confirms, the issue of SOE transparency and governance was consistent with the strategic directions of previous governments. TABLE 2: COMMON REFORM AREAS IN GOVERNMENT PROGRAMS 2000-2008 “The Ukrainian Program “Stability, “Meeting the People “Reforms for Breakthrough: For People not Competitiveness and Program�/ “EU Action prosperity�/ for Politicians� (2007-2009) New Quality of Life� Plan� “European (2006-2007) (2005-2006) Choice� (2000- 2004) Competitive national Establishing conditions to Strengthening fiscal Improving fiscal economy; through: increase investment sustainability situation through • Budget and tax policy; through tax and budget fiscal (including through the reform, financial market transparency, implementation of medium development, and SOEs Adopting an fiscal austerity, and term budget framework, low management infrastructure financing debt reduction fiscal deficits and debt, improvement strategy and pursuing better investment planning, gradual convergence and fiscal decentralization) towards EU principles • Improvement of SOE and standards on management and electricity and gas transparency of the markets privatization program. • Sectoral policies in relation to the financial sector, energy (including through harmonization of the energy market with the European Union) Excerpts from 3rd Development Policy Loan Program Document 21. In its 2007 Program of Action, the Cabinet of Ministers of Ukraine (CMU) included a comprehensive and detailed program to improve the level of transparency, efficiency and effectiveness in the management of SOEs. Among the notable items which comprised the program, actions included improvement of financial planning and reporting, the mandatory publication of financial and economic performance, and the application of transparent mechanisms for determining profitability for the purposes of calculating the transfer of dividends to the state. Additionally, the Cabinet of Minister had indicated its intention to enact the new Management of State Property Law, which will establish, inter alia, the principles of state property management, corporate rights of the state, and improved management functions. 22. Ukraine’s SOE sector has a wide range of ownership and management schemes. In line with Ukraine’s Commercial Code, enterprises fall into two broad categories: state and communal unitary enterprises, and economic enterprises (e.g., joint-stock companies). The first group comprises a number of SOEs with special status (kazenni), that are fully controlled by the government, exempt from certain aspects of corporate law, and enjoy guaranteed state orders, as 8 Basic Elements of the SOE Sector in Ukraine well as unitary (or “ordinary�) SOEs, fully owned by the government, and controlled by ministries or other government agencies, but which have a relatively greater degree of managerial independence. Economic enterprises include share-holding companies, limited liability companies and other integrated companies, which must abide by Ukraine’s corporate legal framework. 23. There is no single government entity with full oversight of the SOE sector and oversight responsibilities are spread across a number of government ministries and agencies. The State Property Fund (SPF) manages all state enterprises undergoing privatization and also has some responsibility to oversee enterprises which have been corporatized. Key strategic firms, such as Naftogaz (which is designated as a kazenni SOE), remain under direct responsibility of the Cabinet of Ministers. Other state-owned enterprises (primarily unitary SOEs) are under the control of ministries and other bodies, which can grant SOE status, reorganize and liquidate state property, and appoint the management independently. The Ministry of Economy is responsible for evaluating SOE performance. STATISTICS AND PERFORMANCE OF THE SOE SECTOR 24. According to the Ministry of Economy (MOE), in 2009 there were 3,589 SOEs (across three different categories – unitary, kazenni and joint-stock companies with government share greater than 50%) operating in Ukraine (see Table 3 below). The total number of SOEs (3,589) reflects the data gathered from the central government but this differs significantly from the records of the SPF Register of State Property. The SPF registry indicates that 4,184 state-owned companies operated in 2009 - the significant disparity in reporting is a concern as it reveals critical weak linkages in the government’s monitoring system. The MOE reportedly is working together with the line ministries and other agencies to address how to reconcile these differences. TABLE 3: BASIC DATA ON THE SOE SECTOR IN UKRAINE 2005 2006 2007 2008 2009 Number of SOEs in 3,981 4,086 3,209 3,546 3,589 Ukraine, including: Unitary SOEs 3,562 3,686 2.765 3,126 3,169 Kazenni 48 50 43 43 43 JSCs with state 419 400 444 420 420 share exceeding 50% SOE share of GDP no data no data no data no data no data Number of 21.0 21.0 15.4 15.3 no data employees in SOEs (percentage of total population employed) SOE share of total no data no data no data no data no data industrial production (percentage) Source: Ministry of Economy, Department of State Assets 9 Basic Elements of the SOE Sector in Ukraine 25. While no confirmed data is available on the SOE sector’s actual share of GDP, the percentage of the people employed by SOEs as a share of the total population employed is a clear indication of the big impact of SOEs on the Ukrainian economy. There are significant additional fiscal linkages between Ukraine’s SOEs and the general government. First, direct gross annual inflows from SOEs to the budget are large. SOEs contribute an important share of tax collections (partial official figures suggest that, in 2005, remittance of current taxes was at least 5 percent of GDP, some 15 percent of total tax revenues), although accumulation of tax arrears has been frequent in the past. In addition, dividend transfers from SOEs have gained importance over time, both as a share of GDP and in terms of government revenues. Second, gross transfers from the budget to SOEs have grown recently, to about 5½ percent of GDP in 2005-06. Third, Ukraine’s government has provided explicit and implicit guarantees to SOEs. Data on the stock of explicit government guarantees to SOEs is not available, since official figures on total state guarantees do not identify the party contracting the loan, but they provide an upper bound for guaranteed SOE debt. 26. State enterprises’ financial conditions are closely linked to the macro-fiscal risks they may generate. Data availability in this area is very limited, both for specific SOEs, as well as for the sector in aggregate. However, existing figures suggest a mixed picture, hinting at an accumulation of risks. Furthermore, key elements of the fiscal relation between SOEs and the government are discretionary. Notably, the policy for SOE dividend transfers to the budget is insufficiently clear. Transfer requirements have been constantly modified by the Cabinet of Ministers, enforcement has been poor, and vagueness in the framework has led to disputes. The same tax regime applies for the private sector and SOEs, but exceptions exist in practice. For example, Naftogaz enjoyed a special VAT zero-rate on imports and sales of gas to intermediate consumers before 2006. Further, the enforcement of SOE tax collection is weak, partly due to the inability of the State Tax Administration to seize assets from key SOEs.13 LEGAL FRAMEWORK FOR SOE OVERSIGHT14 27. The Commercial Code of Ukraine (CCU) provides the basic legal framework for management, monitoring and evaluation, and oversight of the state-owned enterprises. Additionally, there are numerous other special laws and other legal acts stipulating mandate and functions of the various organizations entitled to manage state assets and exercise monitoring, evaluation and oversight over the functioning of the SOE sector in Ukraine.15 28. The CCU is the primary legal act which defines the main principles for commercial activity and regulates commercial relations. With regard to the public sector, the CCU defines its boundaries and refers to all the entities founded on the basis of the state property as well as entities with the state’s share exceeding 50% or with a share that guarantees that the government has dominant control over the entity’s business activity (Article 22 Paragraph 2). 13 Leonov and Stetsenko (2007), “Analysis of Performance of State-Owned Enterprises.� 14 See Annex 1 for a list of laws and regulations applicable to the SOE sector. 15 Including resolutions of the Cabinet of Ministers of Ukraine; regulations, procedures and rules issued by the Ministry of Economy (MOE), Ministry of Finance (MOF), the State Property Fund of Ukraine (SPF), line ministries, other state agencies 10 Basic Elements of the SOE Sector in Ukraine 29. Article 73 stipulates that if the government/state is a sole founder of a business entity it shall be a “unitary state enterprise�. Unitary state enterprises can either be classified as a state commercial enterprise or a kazenni enterprise. The main difference between the state commercial enterprise and kazenni enterprise refers to the government’s role vis-à-vis the enterprise’s assets and liabilities: • A state commercial enterprise is a state-owned business entity having state’s assets under its economic and commercial control, which is in charge for all the obligations with respect to all its assets. Examples of unitary SOEs include Energoatom, Ukrenegro, and regional railroad companies (e.g., Donetsk, South-Western, Pridneprovska). State commercial enterprise can divest or sell its assets only based on the endorsement of the relevant state governing body. The government in general or governing body in particular is not responsible for the obligations/liabilities of a state commercial enterprise. State commercial enterprise applies public procurement rules and regulations in its business transactions (Articles 74-75). • A kazenni (treasury) enterprise is created in the areas sensitive or vitally important for the government (i.e. sectors restricted for private businesses, or where the government is a major consumer of goods or services, or producing socially significant products or services). Examples of kazenni SOEs include scientific and construction companies, producers of military and medical equipment. Naftogaz, which is a joint- stock company, is also a kazenni SOE. Enterprises in this category cannot simply divest or sell their assets and governing bodies are fully responsible for their obligations/liabilities - and if necessary provide compensation for their losses. Kazenni enterprises also subscribe to public procurement rules and regulations in their executing their business transactions (Articles 74-75). 30. In addition to state unitary enterprises, a second broad category of SOEs are joint- stock companies. As defined in paragraph 2 of Article 22 of the CCU, these enterprises are either fully state-owned corporations and joint-stock companies or those SOEs where the government retains dominant control over their business activities - as a rule these are the joint- stock companies where the government’s share exceeds 50%. This category of SOEs may also include limited liability companies and joint ventures, where the majority shareholder is the government. 31. Ukrainian law establishes different rules regulating the operation, management, oversight and monitoring (including performance evaluation) for unitary and kazenni SOEs versus joint-stock companies and corporatized SOEs. SOEs which are joint-stock companies (where the government still retains shareholdings) are regulated by the legal framework for private sector enterprises listed on the stock exchange (e.g. with respect to audit, transparency and disclosure, financial reporting, relationship with shareholders etc.).16 While unitary and kazenni SOEs are not required to have boards of directors, joint-stock companies 16 The 2008 Law of Ukraine On Joint stock Companies No. 514-VI, the 2006 Law of Ukraine On Securities and Stock market No. 3480-IV and the 1996 Law of Ukraine On State Regulation of Securities Market in Ukraine No. 448/96-BP. 11 Basic Elements of the SOE Sector in Ukraine have appointed boards, which provide guidance to company management on the enterprise’s operations. 32. Responsibilities of the CMU, SPF, line-ministries and other government bodies in managing the state corporate rights are also defined in the Law “On Management of State Assets� (Articles 5-8). This law stipulates that state corporate rights may be managed directly by the SPF or transferred into the management of the third party – so called “authorized person� – selected on a competitive basis. The bidding third party elaborates the financial targets expected to be achieved by the state asset (SOE, joint-stock company or other state corporation) and this is used as criteria for the selection of the authorized person (Article 10). 33. The Law “On Management of State Assets� (Article 16) defines government bodies responsible for monitoring and evaluation, and oversight of SOE performance. In particular the law defines the CMU, SPF, line-ministries and agencies, and state inspection and audit service (KRU) as the main entities with the responsibility for direct government intervention, management and control. Line ministries and the SPF should submit consolidated financial plans of the SOEs (in their respective portfolios) and information on their implementation to the MOE. The MOE reviews these documents and in turn, submits to the CMU, a consolidated report together with the proposals to improve SOE operational performance. According to the requirements of budgetary legislation, the MOE submits to the MOF a consolidated financial plan for SOE, highlighting the impact of the SOE performance on the state budget. Line ministries are responsible to appoint SOE managers and monitor SOEs primarily through the review of in-year reports and through the annual evaluation of performance against the management performance contracts. In cases where boards of directors have been established, line ministries, often in consultation with the CMU, appoint representatives to the board. The SPF, as the primary government agency responsible for joint-stock companies, is heavily involved in the appointment of company management, appointment of representatives to the board of directors, reviews and approves company financial plans, business strategies and is responsible for the evaluation of company performance. The KRU is entitled to audit SOEs to prevent financial violations and such audits are primarily concerned with compliance with budget legislation and other relevant legal acts and are not meant to conform to the principle of an independent (external) financial audit. THE STATE OWNERSHIP FUNCTION 34. While Ukraine has made progress in transitioning to a market-based economy, it still relies on an ownership model with the lead role granted to the Cabinet of Ministers of Ukraine (a legacy from the former Soviet era). In accordance with paragraph 2, Article 141 of the Commercial Code of Ukraine (CCU), all state-owned entities are governed by the Cabinet of Ministers of Ukraine (CMU) which in turn may delegate its powers and functions to central or local government bodies (within the executive branch). Article 5 of the Law of Ukraine “On Management of State Assets� defines a broad range of CMU responsibilities in governing the SOE sector, including policy development, drafting of legislation, selection of governing bodies 12 Basic Elements of the SOE Sector in Ukraine and delegation (to them) of the functions in SOE management, monitoring and evaluation, as well as oversight. The CMU delegates its functions of SOE oversight to the line ministries and agencies as governing bodies (ownership entities) for those enterprises not deemed to be of high national interest or of national security. 35. The government’s ownership function covers a range of roles and responsibilities. While the specific functions are de-concentrated across several ministries/agencies, the government is simultaneously a shareholder, financier, regulator, supervisor, customer and supplier. While the details of the roles of specific ministries/agencies of government area describes further in this section, the most common functions of ownership in Ukraine are related development of sector policy, appointment of company management, review and approval of company financial plans, evaluation of company performance. The distribution of mandates and functions between different government bodies, including delegated functions, is reflected in figure 1 below: FIGURE 1: SOE GOVERNANCE SYSTEM IN UKRAINE Verkhovna Rada (Parliament of Ukraine) State Property Fund Cabinet of Ministers of Ukraine of Ukraine Ministry of Finance Ministry of Line ministries (SOE governing Economy bodies) JSCs created as a Corporatized SOEs and Unitary Kazenni result of privatization JSCs w/ government SOEs Enterprises share > 50% Responsibility for oversight Primary reporting line Secondary reporting line *in the case of kazenni enterprises, the lines of responsibilities running from/to the Cabinet of Ministers operate through the Ministry of Economy 13 Basic Elements of the SOE Sector in Ukraine 36. With regard to influencing and managing SOEs, functional ministries (MOE, MOF) and specialized agencies (the SPF) are legally empowered with the functions of policy development, monitoring and evaluation, and oversight. On a quarterly basis, the MOE and SPF review the financial reports (submitted by line ministries) on the performance of SOEs and in turn, submit a consolidated report to the CMU. Line ministries are required to annually evaluate SOE performance against the targets established in the SOE manager’s contract. This consolidated report can also contain recommendations and proposals to improve the system of SOE monitoring and governance. Cabinet of Ministers of Ukraine 37. The CMU has numerous responsibilities and functions in the management of state assets. Broadly speaking, these responsibilities fall under the three categories reflected in the following table. TABLE 4: RESPONSIBILITIES OF THE CABINET OF MINISTERS IN THE OVERSIGHT OF SOES Functional Area Specific roles and responsibilities Policy and strategic decision • Determines goals for the SOE creation and operation making • Makes decision on SOE creation, reorganization or liquidation • Makes decision on retaining in the state property of the stakes of companies in privatization • Establishes criteria for the evaluation of efficiency of SOE management • Sets procedure for creating and maintaining the state assets register • Approves the list of SOE which have strategic importance for the economy and security Ownership functions vis-à-vis • Appoints governing bodies to exercise management other governing bodies • Entitles state bodies to perform oversight for SOE operation • Sets procedure for dividend transfer to the budget • Develops criteria for selecting authorized persons and companies to be managed by them • Approves decisions of governing bodies on creation, reorganization or liquidation of SOEs which have strategic importance Direct monitoring and • Defines objects and exercises management oversight functions • Develops procedures for managing the state corporate rights and remuneration of authorized persons • Exercises oversight on SOE performance • Approves annual financial plans of such SOEs as natural monopolies and with pre-planned net profit exceeding UAH 50 million • Makes decisions on creation, reorganization and liquidation of kazenni SOE • Initiates unscheduled inspections of SOEs 14 Basic Elements of the SOE Sector in Ukraine 38. While the CMU delegates the state ownership function to line ministries for the majority of SOEs, the CMU does retain a strong role in direct management of the selected SOEs of strategic importance – natural monopolies and SOEs with pre-planned net profit exceeding UAH 50 million. The CMU appoints its representative to participate in the shareholders meeting with a clear mandate from the government and assignments for the meeting developed in cooperation with the line ministries. The government’s representative casts his vote in strict compliance with the CMU’s guidelines and reports back on the results of the meeting and decisions made. CENTRAL GOVERNMENT BODIES WITH MANAGEMENT FUNCTIONS 39. Line ministries and agencies are the key element in the SOE governance system (including day-to-day management, monitoring and evaluation, supervision and oversight) of the SOEs in their sectors. In accordance with the current legislation the governing bodies (line ministries and agencies) are entitled with a broad set of functions: TABLE 5: SOE OVERSIGHT ROLES OF LINE MINISTRIES AND AGENCIES Functional Area Specific roles and responsibilities Policy development and • Make decisions on creation, reorganization and liquidation strategic decision making of SOEs • Elaborate strategy of SOE development Ownership functions • Approve statutory documents and regulations for SOEs under their management • Conclude and terminate contracts with SOE managers • Exercise management of kazenni SOEs • Manage state corporate rights • Contracting of SOE managers Monitoring and Oversight • Provide annual audits of selected SOEs functions • Designate employees to monitor performance of SOE • Approve annual and mid-term SOE financial and investment plans, and monitoring their execution • Transfer functions of management of state assets to “authorized persons�, and exercise oversight • Maintain register of state assets 40. The SOE oversight system at the level of line ministries and agencies is multi- functional and complex, and consists of the following main activities: (i) selection, appointment, supervision and dismissal of companies’ managers; (ii) review and approval of the financial plans and performance targets, and monitoring of their implementation; (iii) operational, financial and managerial oversight and supervision; and (iv) review of SOE financial reports, evaluation against the approved targets and decision making based on their results. 15 Basic Elements of the SOE Sector in Ukraine 41. An overwhelming majority of the SOEs report to line ministries/central agencies and the SPF. Line-ministries (and agencies) are responsible for the management of unitary SOEs (both commercial and kazenni), state corporations and corporatized state-owned companies.17 Line ministries are responsible for the submission of the consolidated financial plans for all the SOEs under their management. Separate from the general SOE portfolio, the line ministries submit plans/reports for the natural monopolies and the enterprises with net profits exceeding UAH 50 million. THE STATE PROPERTY FUND OF UKRAINE 42. The SPF is granted with dual functions with respect to the state’s obligations in joint-stock companies, as established in Article 7 of the 2006 Law “On Management of State’s Assets�. The SPF is mandated to manage the state’s corporate rights (government’s interest as shareholder) of the joint-stock companies, which were established as a result of the privatization process. Additionally, the SPF also monitors SOEs which have been corporatized (and which technically remain under the supervision of line ministries) and joint-stock companies where the government shareholding is greater than 50%. 43. The State Property Fund has a special status envisaged by the Constitution of Ukraine and is governed by a special law on the SPF. The SPF is unique from central government in that it manages virtually all aspects of state corporate rights (including appointment of company management, representation in shareholder meetings, appointment of representatives to boards of directors, etc.) for joint-stock companies – particularly where the government is the majority shareholder. The functions of the SPF as defined by the current legislation are numerous and at times, duplicate the roles of other ministries/agencies with regard to SOEs which have been corporatized but which are still under the complete control and ownership of the government. While the SPF reports directly to the Verkhovna Rada (Parliament of Ukraine), the SPF coordinates its activities with the CMU and other central government agencies/ministries responsible for SOE oversight and management. The 18 breakdown of functions assigned to the SPF is as follows : TABLE 6: RESPONSIBILITIES OF THE STATE PROPERTY FUND IN THE OVERSIGHT OF SOES Functional Area Specific roles and responsibilities Policy development and • Makes decision on creation, reorganization and liquidation strategic decision making of SOEs under its management • Makes decisions on transfer of state assets to the statutory funds of business entities • Approves decisions on alienation of state assets • Submits to the CMU proposals on retaining stakes in privatized joint-stock companies • Transfers SOE management functions to other governing bodies upon CMU decision 17 Created as a result of corporatization and in accordance with special legislation requiring large state companies to reorganize into corporations or joint-stock companies. 18 As defined by the Law of Ukraine “On the Management of State Assets�. 16 Basic Elements of the SOE Sector in Ukraine • Develops criteria for the evaluation on the efficient management of state corporate rights • Develops the dividend policy, in cooperation with the MOF and MOE Ownership functions • Acts on behalf of the state as a founder of economic entities with state assets • Appoints representatives of the state to the governing bodies of joint-stock companies Monitoring and Oversight • Ensures operation of the state assets registry system functions • Maintains registry of state assets, including state shares in joint-stock companies • Exercises oversight for the efficiency of management state corporate rights 44. The State Property Fund is primarily responsible for oversight of joint-stock companies – many of which are also SOEs where the government retains the majority controlling share. As the SPF acquired significant experience in dealing with the corporate sector, the government expanded its mandate and assigned additional functions with respect to the state corporate rights, in particular, in the area of policy development, monitoring and evaluation, oversight, and design and maintenance of an asset registry system. MINISTRY OF ECONOMY 45. As defined by the 2007 Cabinet of Minister Resolution #832, the Ministry of Economy (MOE) is responsible for monitoring and evaluating SOEs and for developing policy and reform proposals regarding privatization and state property rights. The MOE is also charged with the responsibility to prevent SOEs from falling into bankruptcy and to restore their financial solvency. The MOE relies on a dedicated department to coordinate the SOE oversight work through collaboration with the MOF, the line ministries and other agencies (e.g., the SPF). 46. The MOE’s primary role is to monitor and evaluate SOE financial plans and implementation of the plans. The MOE receives drafts of the consolidated financial plans from line ministries, evaluates them against the government’s overall strategic objectives and provides either a clearance or objection (and sends the draft back to the ministries for further development in the case of issuing an objection). Additionally, the MOE submits these consolidated financial plans to the Ministry of Finance as an input to the budget process. MINISTRY OF FINANCE 47. The role of the Ministry of Finance (MOF) regarding the oversight of SOE performance is limited (as compared to the role of the MOE), and is primarily related to 17 Basic Elements of the SOE Sector in Ukraine the impact SOEs may have on the national budget.19 SOE financial plans (consolidated plans are passed on to the MOF by the MOE) are evaluated by the MOF within the budget planning process. Although Ukraine still utilizes a single year budget, the MOF uses a medium-term perspective in analyzing an SOE’s impact on both revenues and expenditures. In case of a large negative impact to the budget, the MOF may provide objections and send them back to the relevant line ministry. Financial plans of natural monopolies and SOEs with a [planned] net profit exceeding UAH 50 million are submitted separately (i.e., not included in the consolidated MOE report for the SOE sector) to the MOF for clearance (and submitted then to the Cabinet of Ministers for an additional approval). GOVERNMENT AUDIT ORGANIZATIONS 48. The State Control and Revision Service (KRU) is the central internal audit group responsible for the financial control and audit of the use of public resources – but its work is primarily compliance-focused. While the KRU is undergoing a significant transformation (the government is implementing the EU’s PIFC model for internal audit), KRU’s audit approach is still limited to ensuring compliance with budget directives and as an arm of the MOF, to ensuring overall fiscal discipline. KRU limits its work with respect to the budgetary resources a SOE receives and does not audit its overall finances. The KRU may undertake inspections of individual enterprises under two circumstances: (i) if the SOE was selected for a scheduled inspection in accordance with the KRU’s annual plan, or (ii) in response to an order from the CMU and the MOF that commissions such an inspection. 49. The primary role of the Accounting Chamber is limited to auditing a SOE with regard to the use of budgetary resources. The scope of Accounting Chamber’s general audit work does not include attesting to the reliability of financial statements, reviewing the enterprise’s internal controls, or reviewing the general operations of a SOE. The Accounting Chamber (the Supreme Audit Institution of Ukraine) does not conduct regular performance or value for money audits of SOEs. The Accounting Chamber may, in response to a direct request of Parliament, conduct a special review of a SOE (see box 4 in Section 3). TRANSPARENCY AND DISCLOSURE 50. Ukraine has relied on traditional frameworks for corporate financial reporting (including accounting standards), and public access to information. All SOEs are required to produce their financial statements on the basis of Ukraine’s National Accounting Standards. These standards, which were recently upgraded through the amendment to the Law on Accounting and Financial Reporting, are required to “not contradict� International Accounting Standards. The recently amended Securities and Stock Market Law requires all joint-stock companies, in addition to disclosures based on national accounting standards, to disclose information on their operations, which should be based on International Accounting Standards and in accordance with the procedures established by the Securities and Stock Market 19 The responsibilities of the MOF are defined under the 2006 Cabinet of Ministers Regulation #1837 and are also defined in the Law of Ukraine “On the Management of State Assets� and the accompanying Cabinet of Ministers regulations to the law. 18 Basic Elements of the SOE Sector in Ukraine Commission.20 Joint-stock companies, which fall under the supervision of the SPF, are required to have their financial statements audited on an annual basis; unitary and kazenni SOEs are not required by law to have their financial statements audited annually. 51. The Ukrainian Constitution21 establishes the basic framework for public access to information, and this was further developed under the 1996 amended Law on Information22. Information is first generally classified either as open or limited access. Information determined to be of limited access is further designated as confidential or of significant national importance (state secret) which is subsequently governed by the Law on State Secret. As unitary and kazenni SOEs are public entities, they are subject to the laws on information and state secrets. 20 2008 Accounting and Auditing Report on the Observance of Standards and Codes (ROSC). 21 Article 57. 22 This law was first enacted in 1992. 19 Assessment of Ukraine’s SOE Oversight System SECTION III: ASSESSMENT OF UKRAINE’S SYSTEM OF SOE OVERSIGHT 52. Although the size of the SOE sector in Ukraine is significant, the system of management and oversight is complex and ineffective. The current legal framework has not yet been upgraded to reflect modern corporate governance, ownership and disclosure functions and practices. SOEs still generally operate with unclear mandates and enterprises are not required to establish clear objectives to guide their operations which in turn make performance assessments a difficult endeavor. The Ministry of Economy has the responsibility to monitor and evaluate the financial performance of SOEs but this function can be strengthened. State ownership functions are muddled, and, except for the state corporate sector (joint-stock companies where the government share is less than 50%), the level of transparency and disclosure is poor and inadequate. Ukraine has separate financial reporting and disclosure requirements for SOEs falling under the responsibility of the central government and those which fall under the responsibility of the State Property Fund (e.g., for enterprises which are under the responsibility of the State Property Fund, companies are required to submit annual audited financial statements while there is no such requirement for unitary or kazenni SOEs). LEGAL FRAMEWORK FOR SOE OVERSIGHT 53. In order to create an equitable and competitive business environment (vis-à-vis the private sector), a modern legal framework should separate the functions of state ownership and formulation of industrial policy. One of the key components to a modern legal framework is to ensure a standardized and consistent form and legal status of SOEs. Additionally, the legal framework would clearly and coherently delineate the ownership roles and lines of accountability (e.g., oversight, monitoring, etc.) and support the underlying corporate governance practices across all levels. A strong legal framework would require SOEs to develop clear objectives (commercial and social or public policy objectives), which in turn would enable the development of a strong performance measurement framework assessments and support high levels of transparency. Lastly, a strong legal foundation would set limits for explicit government financial support to SOEs and force SOEs to access capital financing on competitive rather than preferential terms. 54. In Ukraine, while the legal form and status of SOEs is somewhat well defined, the current legal framework in Ukraine for SOE oversight does not provide for an adequate separation of industrial policy formulation and state ownership (including the oversight function). Line ministries, which are responsible for establishing sector policies and regulatory frameworks, are also responsible for effectively discharging the state’s ownership function. The Commercial Code of Ukraine (CCU) does not require SOEs to develop objectives to guide their operations which often results in an enterprise trying to manage multiple, and often competing, mandates. While management and oversight functions are delegated to various government bodies and agencies, the lines of accountability are actually weakened by the fact that there is no single repository for information and no single ministry or agency is responsible for ensuring enterprises comply with legal obligations (e.g., payment of dividends, annual performance evaluations). As shown in tables 4, 5 and 6, there are overlapping roles by different government 20 Assessment of Ukraine’s SOE Oversight System offices in setting policy, enforcement of legal obligations, monitoring performance. Moreover, well established underlying corporate governance practices (including transparency and disclosure) are not fully developed in the current legal framework. 55. While the regulatory framework for joint-stock companies is being strengthened (though unitary and kazenni SOEs are not covered), some weaknesses may still endanger minority rights. The CCU provides for various types of legal entities, including SOEs (Chapters 8 and 12). Until recently, regulations had important loopholes which led to asset-stripping practices. Public state-owned corporations (joint-stock companies) and state-owned holdings are subject to the general corporate legal framework, but this remains incomplete and ambiguous, and prone to inconsistencies in judicial interpretation. Finally, the inability to seize assets from SOEs continues to raise creditors’ risk and minority rights. New laws on holding companies and state property management were approved in 2006, but their full effectiveness remains to be seen. The legal framework for SOEs is in need of modernization. It is important not only to clearly define what the roles of management and oversight entail, but also to clarify which government ministry/agency is responsible for executing these functions. In defining the arms-length relationship between government and SOEs, the legal framework should also define or limit the government’s financial influence/role particularly with regard to limiting the state’s guarantee for SOE debt and liabilities. Establishing clear operating objectives for SOEs is an essential component to improving the quality of oversight as it establishes a clear benchmark by which to evaluate performance. There is also a critical need to incorporate modern corporate governance practices and requirements in the legal framework. THE STATE OWNERSHIP FUNCTION 56. A state’s ownership policy, underpinned by a strong corporate governance framework and separated from its regulatory function, should clarify the ownership rights within the central administration and limit the involvement of government in the daily management of SOE operations. A consistent and effective ownership policy provides the general public with a clear understanding of the state’s objectives as an owner as well as its long term commitments and strives to ensure that the ownership function is fulfilled in an efficient and accountable manner. An important part of the state’s ownership function is to develop and implement a well articulated dividend and investment policy23 – balancing the need for SOEs to manage their operations with a degree of independence with the need to preserve accountability. The ownership policy should also clearly articulate the mechanisms through which the performance of SOEs will be monitored. The state has a clear interest in ensuring that SOE performance is strong and a well defined ownership policy, along with strengthened transparency and reporting frameworks, enables the application of more vigorous performance management systems. 23 This policy should also include issues such as liquidation or sale of assets, reallocation of capital, divestures, mergers and acquisitions, changes in capital structure, etc. 21 Assessment of Ukraine’s SOE Oversight System 57. The system of governance is complex, and in practice there is no single agency responsible for the SOE sector or for the functions of industrial policy. Despite the powers granted to the CMU, an overwhelming majority of the ownership functions are delegated to line/functional ministries and agencies. It is clear that, in reality, Ukraine relies on a highly decentralized system of governance and oversight of SOEs with a large number of governing bodies involved, in different capacities, in management, monitoring and evaluation, and oversight. There are two broad categories of the central executive bodies which are responsible for the oversight of state-owned enterprises: (i) ministries and agencies (mainly line ministries and the SPF) directly managing SOEs within their areas of responsibility, and (ii) coordinating ministries and agencies with monitoring and oversight powers (MOF, MOE, KRU). 58. In practice, line ministries primarily exercise their SOE oversight function through a review of the reports on the implementation of financial plans – though this is typically a light review. Annual financial plans include performance targets with their quarterly (intermediate) indicators. In case of significant deviations from the approved targets and indicators the line ministry may intervene in an attempt to improve the situation. As noted before, there is no evidence to support that reported data/results are validated, which thereby brings into question the reliability not only of the data itself, but of the effectiveness of the review and oversight function. 59. In analyzing the governance and oversight system of unitary SOEs (those which are not joint-stock companies), there are gaps in actual practice as compared to international good practice. For example, according to Ukrainian legislation, unitary SOEs are not required to have Boards of Directors and are governed on the basis of a principle of one-man management inherited from the old Soviet system of control. In practice this means that all important business and operational decisions are made through the manager of the supervising line ministry. PERFORMANCE MANAGEMENT 60. An SOE’s performance evaluation is normally a core function of the company’s board of directors and typically measures both financial and non-financial indicators of business performance. In assessing performance, the evaluation first ensures that the SOE’s operating objectives and business performance targets are in alignment and to make certain that the company does not lose focus on its core activities. The performance framework should include a SOE’s subsidiaries in order to conduct a complete and comprehensive assessment. For measuring non-financial indicators, it is important to measure business and service performance standards, including pricing and cost recovery, particularly if a company has public service or social objectives. With regard to measuring financial performance, typically there are a series of indicators used to measure profitability, commercial value, credit worthiness, etc. Additionally, it is important to review a SOEs borrowings, lines of credit and guarantees as an additional measure of the company’s financial position. Typically in evaluating the financial indicators, the use of cash flow analysis (e.g., in measuring rates of return of capital expenditure, debt servicing, etc.) and the discounted cash flow methodology is standard; the use of the economic value-added 22 Assessment of Ukraine’s SOE Oversight System analysis is becoming more common today. Moreover, the underlying financial data used for these analyses (and performance measurement) is validated by an external or third party (e.g., independent financial analysts, independent auditors, credit rating agencies, etc.) in order to ensure completeness and accuracy in the baseline valuations. 61. In Ukraine the methodology for evaluating the performance of SOEs is weak and further work is needed to upgrade it. The methodology relies on a very narrow set of evaluation criteria which refer to the SOE’s self-reported results on financial and economic performance indicators. Without having established objectives, it is difficult to measure a company’s performance as business or service standards are not clearly identified. In addition, the financial indicators of the current performance framework rely on invalidated data, and as elaborated further in this section, the basis for accounting (Ukrainian National Accounting Standards) differs significantly from international standards, thereby questioning the reliability of financial results. The current framework also does not contain criteria to measure the efficiency of service delivery or production standards. BOX 1: PERFORMANCE ASSESSMENT CRITERIA FOR UNITARY AND KAZENNI SOES Non-commercial criteria (used to compare Defined by the 2007 MOE Order #314, the against results from the previous year): average evaluation of SOE and management performance number of employees; average salary; wage is graded as follows: arrears; social expenditures Commercial criteria: sales (rate of growth); net (1) positive (efficient) management profit; share of net profit paid to the state budget; (2) satisfactory management dividends on share in state-owned JSC (compared to targets in financial plans) (3) negative (inefficient) management Assets, investments and innovations criteria: value of assets; value of net assets; capital investments; depreciation of fixed assets Financial efficiency criteria: return on assets; profitability; financial stability; current ratio; liquidity ratio; capital ratio State assets utilization and preservation criteria: manager’s compliance with terms of contract; competitive selection of managers; alienation of state assets in compliance with the law 62. Supervising line ministries are legally empowered to select SOEs managers on a competitive basis and enter into contracts with them based on the development strategy and performance indicators. The new competitive mechanism has been introduced recently, but there is a strong view that so far it did not make any significant changes to the routine system of appointing managers. Remuneration policy is an important instrument of the line ministries in managing SOEs but it appears to have not been effective in attracting top candidates to manage public enterprises. Ukrainian legislation empowers line ministries to grant adequate24 remuneration packages for the managers for their contribution in SOE’s performance. But as is 24 As defined in the Law of Ukraine “On Management of State Assets�. 23 Assessment of Ukraine’s SOE Oversight System widely observed in Ukraine, the remuneration of successful managers is apparently substantially lower than remuneration of their colleagues from the private sector. 63. Although line ministries supervise SOE managers on their compliance with the terms of contracts and the achievement of performance targets, the assessment methodology requires upgrading. Complicating matters is that the performance criteria used to evaluate the performance of SOEs which are joint-stock companies is different from the criteria for the evaluation of unitary and kazenni enterprises. BOX 2: PERFORMANCE ASSESSMENT CRITERIA FOR JOINT-STOCK COMPANIES Categorization of joint-stock companies for the Grades applied for groups 1 and 3 assessment of management performance Efficient - Company has no or reduces overdue payables and wage arrears; all commercial In applying the performance criteria, all state- indicators are positive; no reduction of employees; owned JSC are divided into four groups (defined dividends paid in the amount set in financial plan; by the 2009 SPF Order #694): assets value increased. Group 1 – joint-stock companies where the Satisfactory - Company has no or reduces overdue state's share exceeds 50% payables and wage arrears; more than five of commercial indicators are positive; no reduction of employees; dividends paid in the amount set in Group 2 - joint-stock companies where the financial plan. state's share is 50% or less Inefficient - all other cases Grades applied for group 2 Group 3 - joint-stock companies which have Efficient - Company has no or reduces overdue strategic importance payables and wage arrears; all commercial indicators are positive; no reduction of employees; in previous year dividends have been paid; assets Group 4 - joint-stock companies in the process value is expected to increase of bankruptcy Satisfactory - Company has no or reduces overdue payables and wage arrears; more than five of Commercial Indicators: (i) sales, (ii) net profit, (iii) commercial indicators are positive; no reduction of share of net profit paid to state budget employees Inefficient - all other cases Non-Commercial Indicators (as compared to Grades applied for group 4 previous year): (i) average number of employees, Efficient - Company has no or reduces overdue (ii) average salary, (iii) payments to social funds payables and wage arrears; no reduction of employees; profitability rate is within projected range Satisfactory- Company has no or reduces overdue payables and wage arrears; no reduction of employees; profitability rate is beyond projected range Inefficient - all other cases 24 Assessment of Ukraine’s SOE Oversight System 64. Dismissal of a manager, even in case of poor performance and/or non-compliance with the contract, is a major challenge for the line ministries. In the first quarter of 2009 line ministries terminated 36 contracts against 35 in the last quarter of 2008 (120 contracts were terminated across the sectors and ministries in all of 2008). A manager who has been fired may appeal his termination of contract. Widely publicized cases noted that terminated managers pointed to a wide range of external factors (including government intervention into operations and management) which contributed to an SOE’s poor performance. Given that the methodology and criteria for assessing a manager’s performance is weak and ambiguous, line ministries often lose these cases resulting in the reinstatement of the manager. Performance management will be successful only once clear objectives have been established. The framework for SOE performance management should require that the underlying data used to populate indicators are validated and reliable. While SOEs should continue to report on their performance, the reported indicators should be subject to testing or validation rather than mere aggregation for further reporting. The performance indicators (and including financial and non-financial indicators) themselves should be able to measure business or service standards so as to enable comparison of actual results against business and corporate plans. The performance framework should, at the very least, ensure that an SOE’s operations are financially viable and that the company itself is financially healthy and sustainable. MINISTRY OF ECONOMY 65. While the MOE monitors the profitability of the SOE portfolio, it is not clear what actions, if any, are taken to help the lagging or weak performing enterprises improve their operations to become profitable. According to the financial reports produced by the MOE, 1,739 SOEs reported a net profit in 2008 (compared to 1,786 SOEs reporting a profit in 2007) and 659 SOEs reported net losses (compared to 699 SOEs in 2007). Additionally, the MOE determined that 134 SOEs “operated on the edge of profitability,� indicating (according to the MOE) that these enterprises could become profitable either through restructuring or through improving management. 66. The mechanisms for financial planning and monitoring of SOEs are gradually improving, but some still weaknesses persist. The CCU (Article 75) mandates SOEs to prepare annual and quarterly financial plans, which they submit to the ministries or government bodies that have direct oversight responsibility. Since March 2006, the Ministry of Finance has had the explicit mandate to coordinate and agree the financial plans; however, data coverage and content requirements have been continuously modified, and there have been significant delays in the agreement of the plans. This has made performance monitoring by the Ministry of Economy difficult. Further, while SOEs may issue debt on domestic and international markets without 25 Assessment of Ukraine’s SOE Oversight System prior government approval, they have only recently been required to submit detailed information on their assets and liabilities to the central government authorities. 67. In exercising its oversight function, it is not clear if the MOE is actively involved in assessing SOE performance. The MOE receives from line ministries, quarterly and annual reports on the implementation of the SOE’s financial plans. In turn, the MOE prepares consolidated reports for the SOE sector and submits them to the MOF and to the Cabinet of Ministers. Additionally, the study was unable to identify what actions are taken by the MOE or other central body in response to reported failures to achieve important targets. 68. While MOE works with the ministry to examine the reasons behind the weak results (satisfactory or negative ratings), and subsequently submits to the Cabinet of Ministers proposals for how to improve ministerial SOE management, it is not clear what effect this evaluation system has in terms of driving performance. The MOE uses a scoring system to evaluate the performance of line ministries in the execution of their role to oversee SOEs. The MOE provides three types of scores to the governing bodies (mainly line ministries) as a mean of assessing efficiency of managing their portfolio of SOEs: (i) positive if more than 75% SOEs reached the approved target results, (ii) satisfactory between 50 and 75% SOEs achieved their results, and (iii) negative if more than 50% of SOEs failed to reach the target results as envisaged in their approved financial plans. In 2008, 12 out 68 governing bodies were rated as positive (efficient), 25 as satisfactory and 31 as negative (inefficient). The number of positive scores increased and the number of satisfactory scores decreased in comparison with the 2007 results of ministerial performance. 69. While the MOE is entitled to check evaluation results of SOEs and SOE managers made by the line ministries, this is a limited function in practice. If the MOE were to check the assessment results, the review work is actually limited to a desk review of submitted documents or a recalculation of self-reported indicators. No data validation takes place and there is no direct audit or field work conducted by MOE staff to ensure the accuracy of reported results. As previously noted the performance assessment framework is not comprehensive and misses certain key dimensions to measure business standards and service delivery. In addition, the underlying data used to generate the indicators may not be completely reliable. 70. There is a disconnect between the assessment of an SOE manager’s contract and the assessment of SOE performance – the number of managers with a positive rating is 2.6 times higher than the number of enterprises rated as such. The MOE reported that in 2008 199 SOE managers were assessed as underperforming, while only 83 contracts had actually been terminated. Moreover, 1,804 SOE managers were assessed as successfully achieving their targets while only 695 enterprises were evaluated as positive. Additionally, 326 SOEs were evaluated as “not efficient� according to the assessment of line ministries. 71. Moreover, there appears to be significant gaps in the coverage of SOE performance assessments. The 2008 MOE reported disclosed that line ministries did not conduct performance assessments for almost a thousand SOEs. While this information was apparently 26 Assessment of Ukraine’s SOE Oversight System submitted to the Cabinet of Ministers, it is not clear what disciplinary action, if any, was taken as recourse for non-compliance. MINISTRY OF FINANCE 72. While the MOF is responsible for ensuring that SOEs comply with the dividend rates (as established by the CMU) and remit payments to the national treasury, gaps remain in ensuring compliance with the dividend policy. The revenue targets for line ministries are based on projected SOE profits. In some cases, a line ministry can meet the revenue targets by collecting a high dividend rate from a few highly profitable enterprises – thereby effectively exempting from payment of dividends those SOEs with lower revenues. While line ministries and other government bodies produce reports on the implementation of SOE financial plans, (including indicators on the transfer of dividends to the state budget, capital investments, etc), the 2008 MOE report indicated that only 71.4% of the anticipated dividends had been transferred to the state treasury. 17 ministries were reported to have not met the target regarding the net profitability of their SOE portfolio and transfer of dividends. 73. The MOF does not perform an active or have a direct oversight function. While the MOF monitors the implementation of financial plans, it does not evaluate individual SOEs with regard to performance nor does it review the finances of SOEs. Rather, the MOF evaluates the performance of the supervising line ministries, using indicators such as the remittance of dividends to the state budget – though, as previously noted, ensuring the receipt of dividends is not always a consistent practice. In case of deteriorating performance indicators (lower than anticipated divided receipts), the MOF has a right to inform the CMU regarding the ministry’s managerial practice and performance – but it is not clear what impact this has in terms of improving SOE performance. MOF can also commission the state inspection and audit service (KRU) to carry out inspections and audit work for either an entire SOE sector or for a selected enterprise. There is a basic need to establish a single comprehensive database of basic financial data for all SOEs. As the government is the ultimate guarantor of SOE debt and liabilities, it will be important to develop a framework and criteria to be used to evaluate SOE requests to access capital financial vehicles (loans, credit lines, guarantees, etc.) or to issue bonds or other debt instruments. While the process to review, evaluate and approve (or reject) such requests is supposedly centralized, observed practice demonstrates that this procedure is in need to strengthening and enforcement. Likewise, there is a need to strengthen the monitoring tools and procedures to ensure that dividends are remitted to the national treasury. STATE PROPERTY FUND 74. The SPF exercises oversight not only for the SOEs under its management, but also for all joint-stock companies which are managed by line ministries. At the beginning of the period of transition to a market economy, the State Property Fund was established as a leading agency for the privatization of the state assets and possessed the necessary capabilities (and legal 27 Assessment of Ukraine’s SOE Oversight System basis) to lead this process. The SPF was granted the additional responsibility to manage the government’s remaining stakes in the privatized companies. Over time, the SPF’s mission evolved and it began to focus its efforts to improve the performance of public enterprises before privatization – as an attempt to increase the value of their assets. At present, the registry of state assets (database) maintains the state’s shareholdings (including the corporate rights based on % of shares controlled by the government) in 811 joint-stock companies (including 83 limited liability companies with government’s stake acquired by the state in the course of privatization). The SPF is technically responsible for monitoring and evaluating the performance of each of these companies. But of this total number, the SPF is actively managing and overseeing only 691 SOEs. The remaining 103 joint-stock companies are managed by the line ministries and 17 directly by the CMU (large strategic JSC called “national joint-stock companies� and “state holding companies� but which are not classified as kazenni). 75. In terms of oversight, the SPF demonstrates a more active role than other governing bodies. In analyzing its annual reports, the SPF includes more detailed quantitative and substantive analyses. The SPF also conducts additional levels of monitoring and evaluation, including the issuance of an annual report which incorporates the enterprise’s audit findings and reported quarterly indicators and results.25 In part this is due to the stricter reporting, transparency and disclosure requirements of joint-stock companies enforced by the State Securities and Stock Market Commission. Additional impetus for improved company reporting (and in-turn, improved SPF monitoring and analysis) also comes from the fact that company information is made publicly available to stock market participants, investors, investment banks, and other interested parties. 76. The current practices and methodologies for maintaining records are not adequate to enable a proper evaluation of SOE assets, as the registry is based on incomplete company data. As the agency’s mandate has been expanding, the SPF was delegated the responsibility to create and maintain the registry of all state assets, which covers all SOEs and joint-stock companies where the state holds shares. The incomplete coverage of SOEs limits the effectiveness and quality of monitoring and oversight. The current design of the asset database is such that selected SOEs may be registered separately from its subsidiaries and other units. As a result, the asset registry system disguises the overall picture of SOE performance, in particular the total value of its assets and liabilities. Use of the asset registry information to evaluate company performance is considerably less accurate. 77. The SPF-managed asset registry is not the sole source of data regarding state assets (including the number of SOEs currently operating) and the comparison with data gathered from other government offices reveals a serious weakness in the reliability and comprehensiveness of basic information and statistics. Similar statistics on state property and assets are maintained by the State Statistics Committee, which presents a completely different set of data, including the number of SOEs in operation. One of the tasks of the government (Ministry of Economy) is to reconcile this data and submit it to the Cabinet of Ministers in its annual report on SOE performance. 25 The audit and financial reporting requirements for joint-stock companies are different from the requirements for unitary and kazenni enterprises. 28 Assessment of Ukraine’s SOE Oversight System It is clear that the government (through the CMU, line ministries or MOE) is heavily involved in the day-to-day management of SOEs, whereas its role should be focused on broad oversight of the SOE sector as a whole – e.g., performance monitoring, ensuring compliance with regulations, fiscal frameworks, transparency and reporting requirements, etc. Direct operational oversight is normally the responsibility of boards of directors. Given the large number of SOEs currently operating in Ukraine, there is limited usefulness of such close government intervention as it is not possible to effectively or efficiently supervise such a large portfolio of companies. GOVERNMENT AUDIT ORGANIZATIONS 78. International practice shows that SOEs increasingly are being asked to report to their supervising ministries on their risk management systems – of which internal audit is an important component. This approach is consistent with the trend away from trying to control specific aspects of operations (e.g., salaries or investment decisions) and towards broad- based performance and risk monitoring. This approach is yet another demonstration of how practice of SOE oversight is moving to allowing for greater operational autonomy (implementing the “arms-length� relationship between government and the enterprise). Risk management is a primary oversight responsibility of the board of directors and specifically of the board’s audit committee. This responsibility includes ensuring that internal control processes are in place throughout the company to effectively identify risks, setting acceptable levels of risk, and taking measures to mitigate or respond to risk. Internal audit reinforces risk monitoring and is seen as an integral part of the overall risk management system, which in turn is itself a critical component of enterprise management and strategic planning. 79. SOE oversight has two primary components - (i) performance indicators and (ii) ex- post inspection by KRU – and efforts are being made to strengthen the internal audit function of government. While SOEs supposed to have in place internal audit units, the government’s internal audit service (KRU) in effect fills this role. Cabinet of Ministers Decree No. 955/ 08 (August 2001) defines the general scope of work and provides the basic procedures for planning the KRU inspections and revision activities. In January 2006, amendments to the state auditing law granted authority to the KRU to undertake financial and performance audits of SOEs. Essentially all of KRU’s revision and inspection work is still based on the ex-post compliance review of transactions, ensuring that the transaction conform with the appropriate budget expenditure line, that revenue collections are recorded properly and that assets management (including safeguarding of assets and asset valuation) is performed. The KRU is developing methodologies and preparing a work program to audit and strengthen SOE oversight, although it is not yet clear whether the approach will be fully consistent with the public internal financial control concept adopted as the KRU’s long term goal. Nevertheless, it will also be important to ensure that internal audit groups in SOEs function effectively in addition to the program to reform the central government internal audit function, and that these groups complement, rather than substitute, the role of an annual external audit (see next section on Transparency and Disclosure). 29 Assessment of Ukraine’s SOE Oversight System 80. KRU’s oversight function is not limited to ex-post inspection and recently it had been granted the mandate to perform ex-ante expenditure control in the largest and most strategically important SOEs. In May 2009 the CMU assigned KRU with a new mission – to monitor the financial transactions of the 42 largest and strategically important SOEs.26 This new role expected that the KRU auditors were to review risky and complex/large financial transactions. This initiative was intended to assist government activities to promote more effective preventative services and better practices to uncover illicit or illegal practices. Past experience demonstrates that such findings usually do not result in meaningful change or improvement, if any (see box 3 below). BOX 3: KRU REPORT ON THE INSPECTION OF STATE JSC KHLIB UKRAINY, JUNE 2009 KRU completed an inspection of the financial and economic activities of State Joint-Stock Company “Khlib Ukrainy� (Bread of Ukraine) – the largest enterprise involved in the production of bread-grain and related products. The work included an inspection of the parent company as well as 69 subsidiaries; the most significant findings are summarized below: • The company’s statutory fund (as established by a CMU resolution) was expected to be UAH 1.4 billion. The inspection found that the company cannot confirm the existence of UAH 608.4 million worth of assets in the statutory fund. Dissolution of assets in an SOE which is 100% state-owned is a violation of the law. • The company has failed to repay loans (un-quantified amount) extended by the government for seasonal purchases of grain. • UAH 50 million were diverted from the company’s activities. For example, company has bought shares in other companies without having clear plans or specified use for the purchases of shares. UAH 7.8 million worth of company stock disappeared from the custodian bank. • Company’s debt to the state reserve for the supplied 860 thousand tons of grain totals UAH 2.6 billion that exceeds twice the value of the company’s assets. The company does not include on its balance sheet, the debt incurred as a result of 250 thousand tons of wheat supplied from the state reserve. • The company does not comply with procurement law and purchased UAH 190 million of goods on a non-competitive basis. • During 2007-2008 the company’s board failed to develop financial plan of the company. The company has routinely not submitted data to the state statistics committee. The company’s board has ignored a previous KRU recommendation that the company’s assets should be accounted for based on real (market) value rather than on a historical cost basis. 81. Supreme Audit Institutions (SAIs) characteristically have an important and regular function in SOE oversight and their scope of work usually includes the SOE as well as the supervising/ownership ministry. SAIs normally are not appointed to conduct the annual external (or independent) financial audit of an individual SOE (though in many countries SAIs can sub-contract this work to private sector audit firms). Increasingly, SAIs conduct 26 May 2009 Cabinet of Ministers Resolution #506 30 Assessment of Ukraine’s SOE Oversight System performance audits at regular intervals (usually every three to five years), focusing their work on the effectiveness and efficiency of the implementation or execution of an enterprises’ operations. An SAI’s work is not normally limited to auditing or reviewing on the use of budgetary resources but rather its work is more comprehensive and includes an enterprise as well as its subsidiaries. 82. The Accounting Chamber does not audit SOEs as its oversight role is limited to reviewing compliance with regard to the utilization of budgetary resources. As the Supreme Audit Institution of Ukraine, the Accounting Chamber operates independently of the executed branch. It usually conducts inspections/audits at the request of the Verkhovna Rada (Parliament of Ukraine), special parliamentary committees or individual parliamentarians. The Accounting Chamber sends its reports to the Parliament and in some cases also to the CMU. There does not appear to be action taken by the government in response to the Accounting Chamber’s findings. BOX 4: ACCOUNTING CHAMBER INSPECTION OF NAFTOGAZ (2006-2008) On March 3, 2009 the Auditing Chamber of Ukraine released its report on audit of the National Joint- Stock Company “Naftogaz Ukrainy� – the largest Ukrainian fully state-owned company involved in production, transportation and distribution of natural gas. The objective of the audit was to review the company’s compliance with its budget obligations – correctness of expenditures of funds received from the state budget and fulfillment of its tax obligations. Among the numerous findings in the report, the key issues identified were the following: • The report stated that company continues to manage its operations in a non-transparent. Information on its financial performance and foreign trade activities is contradictory and confusing. • Solvency of the company to a great extent depends on foreign credits; its financial sustainability and ability to generate profit are very low. Arrears of customers (for consumption of gas) increase from year to year. • The Ministry of Fuel and Energy (supervising ministry) plays a passive role and does not perform the state functions of oversight and control over the company’s activities, as mandated by law. • The company’s financial plan for 2009 (approved with significant delay) envisaged an allocation of state budget resources in the amount of UAH 7.7 billion, while the state budget projected only UAH 1.6 billion in support of the company. Therefore, the financial plan of Naftogaz projected an inherent deficit in the amount of UAH 6.1 billion. • The Ministry of Fuel and Energy has not endorsed the company’s balance and financial report. Moreover, it did not allow the company’s internal audit committee to access the financial information. • The Accounting Chamber came to a conclusion that these violations resulted in misappropriations of UAH 6 billion from the company’s budget. • Wage arrears to the employees have grown significantly. Bad loans increased by a factor of 15. • At the same time, large amounts of resources from the company’s budget go for “sponsorship and charity�. The credit policy of Naftogaz is unsustainable and unbalanced. From 2006 to 2008 the company based its economic and financial activities on attracting credits. As of 2009, the level of company’s debt exceeded UAH 35 billion. In just 2009, the company was projected to pay about UAH 17.5 billion to service its debt stock, which represented nearly 50 percent of its own capital and which could realistically lead to insolvency. 31 Assessment of Ukraine’s SOE Oversight System Between 2006-2008 Naftogaz had not paid dividends and owed to the state budget approximately UAH 3.7 billion, while the company received dividends on its own investments in the amount of UAH 1 billion. The issue of compensation (i.e., subsidy) to the company from the state budget for the difference between the price of imported natural gas and tariffs levied on the population, budgetary institutions and companies producing heating for the population remains very important. The Audit Chamber concluded that manipulations with domestically produced natural gas have been a systemic problem occurring many years. Ukrainian law stipulates that domestically produced natural gas should be used only for the needs of the population. However, during the last two years Naftogaz, in violation of this rule, has sold 11.2 billion cubic meters of natural gas to foreign customers. As a result, shortage of gas for the population in 2006 totaled 4.8 billion cubic meters and resulted in direct losses of UAH 1.7 billion – which was ultimately financed by the state budget. In 2006 the company did not meet demands of population in gas and at the same time pumped into storage facilities about 4 billion cubic meters of domestically produced natural gas. In 2008 the company sold 0.4 billion cubic meters of expensive imported gas to the population and sold cheap locally produced gas to commercial customers. TRANSPARENCY AND DISCLOSURE 83. Broad transparency and disclosure requirements are essential components of any modern corporate governance framework and support efforts to improve the quality and effectiveness of oversight. These requirements, which include the application of international standards for accounting and financial reporting, being subject to an annual external audit, the ex-ante publication of objectives and ex-post publication of results, expose company performance to greater public scrutiny, which in turn provides a strong incentive to improve management, monitoring and to execute more effective ownership rights. 84. While reportable indicators on SOE performance have been established by the MOE, there are gaps regarding the usefulness of such indicators. Line ministries report on SOE performance and these reports cover a range of financial indicators: net income, gross and net profit, costs, liquidity ratio, accounts payable and accounts receivable, assets value, fixed- assets value, wage arrears etc (see Table 7 below). TABLE 7: MAIN FINANCIAL INDICATORS OF SOES, 2007-2008 UAH thousands Financial indicators 2007 2008 Net income 103,327,034 188,216,364.0 Net profit 931,629 12,440,355.6 Accounts payable 22,002,810 61,186,046.7 Accounts payable, arrears 2,651,934 14,064,741.9 Accounts receivable 14,059,538 52,619,715.4 Accounts receivable, arrears 4,534,742 13,788,350.6 Wage arrears 585,021 308,053.9 Fixed-assets value 510,662,923 1,390,311,659.7 Current and long-term liabilities n/a 145,040,967.3 Net assets value n/a 177,987,989.0 Current assets value n/a 103,756,295.8 32 Assessment of Ukraine’s SOE Oversight System Source: Ministry of Economy 85. It is also important to note that these indicators of financial performance are self- reported by SOEs and that there is no evidence of validation of the raw data or of the indicators reported by individual SOEs. The line ministries aggregate the results for the enterprises in their portfolios and submit this information to the MOE – ministries do not report on an individual enterprise level. Any analysis of these reported results in trying to determining the relative performance of an SOE could be misleading. 86. Although publicly owned, SOEs lack transparency. SOEs are not subject to specific public reporting requirements and their accounts and other company information may be treated as a state secret. Opacity undermines performance monitoring, limits accountability, conceals debt that can impose stress and damage to the financial system and creates conditions where corrupt practices go unnoticed and can flourish. 87. In Ukraine, although SOEs follow the requirements of the Law on Accounting27 and use NAS to prepare their financial statements, there are still challenges in complying with existing requirements. Consequently, SOEs experience significant difficulties in applying NAS and the quality of the financial information varies significantly. There are some material differences between National Accounting Standards and IFRS.28 The impact of these differences on the usefulness of financial statements prepared according to NAS as compared to IFRS may in many cases be material (the differences may be even more significant if the NAS disclosure requirements are not followed). The variable quality of financial information, which often inadequately reflects the financial and economic performance of the entity, becomes particularly restrictive when the Government seeks to privatize the entity or the entity seeks other sources of external financing. It is worthwhile noting though, that the MOF has recently (November 2010) taken several steps to upgrade NAS and to eliminate the remaining differences with IFRS. 88. SOEs are required to submit annual financial information to the State Statistics Committee (they are now not required to submit their statements with the tax returns as they were until recently). Additionally, SOEs which generate annual revenue of at least 100 million UAH are expected to submit their financial statements to the Tax Administration. Apart from the limited review of financial statements by regulators, limited to joint stock companies and regulated entities, there appears to be little use made of the financial statements external to the company, its management and owners. According to the 2008 ROSC assessment, limited use of financial statements is made by banks as a basis for loan decisions; collateral-backed lending 27 In addition, these enterprises follow the “Statute of the Accounting Procedure for Certain Assets and Operations of the State and Utilities Sectors of the Economy which Use State or Civic Property,� and often are required to prepare separate reports for various governmental authorities, including the State Statistics Committee, their respective ministries, social funds, tax authorities, etc. 28 2008 Report on the Observance of Standards and Codes (ROSC), Accounting and Auditing Assessment. 33 Assessment of Ukraine’s SOE Oversight System is prevalent. However, there is evidence of increasing demand for, and usage of, financial statements in lending decisions. Areas of noted non-compliance include: • Non-disclosure of related party transactions; • Non-disclosure of the accounting policies adopted; • Non-provision of liabilities for which the measurement is not supported by third party evidence; such provisions are generally not allowable for taxation purposes and would include categories such as holiday pay provision and doubtful debt provision; • Non-provision of deferred taxation; • Non-disclosure of earnings per share; • Assets carried at historical cost where there is evidence of impairment; and • Failure to include a cash flow statement. 89. In general, commercial banks do not rely on the financial statements presented by potential borrowers in determining whether to extend credit. There is a perception among the banks that, with exception of financial statements purporting to comply with IFRS audited by international audit firms, the financial statements of companies in Ukraine are of a low quality and do not represent sufficient basis for assessing the financial position of a potential borrower. Although entities are often required to submit their financial statements as part of the loan application process, banks base their lending decisions on other factors including the amount of collateral, business forecasts and site visits. The financial statements of companies prepared in accordance with Ukrainian NAS and the related auditors’ opinions are seen by banks as indications of merely their tax and legal compliance. SOEs should not have more favorable access to finance (loans, lines of credit, guarantees, etc.) than private sector firms. In Ukraine, if SOEs have access to finance on favorable terms, or if the standards used to grant SOEs access to financial instruments are more lenient or flexible, the government, as the ultimate guarantor for SOE debt and liabilities, will face even greater fiscal pressure. As there would essentially be no hard budget constraint, and couple with the insulation from market forces or market discipline, SOEs will naturally have fewer incentives to more effectively manage their resources or to improve performance which undermines their long-term competitiveness. 90. A few major SOEs (usually joint-stock companies) participating in international capital markets (including Naftogaz) have recently contracted independent external financial audits, but these are not mandated by law and the vast majority of unitary and kazenni SOEs are not subject to independent financial audits. Article 8 of the Audit Law requires that open joint-stock companies, issuers of securities, professional participants of the stock exchange, financial organizations and other entities falling within the categories obliged to make their financial reports publicly available are required to have their entity and consolidated financial statements audited. The requirement for a statutory audit is different from the EU audit requirement, which requires all companies with limited liability to be audited but permits member states to exempt small companies from the requirement to have an audit. The EU sets 34 Assessment of Ukraine’s SOE Oversight System maximum limits on the size criteria for small companies but member states can set smaller size criteria if appropriate for their state. Given the limited current capacity of the audit profession in Ukraine, the statutory audit requirement should be limited to those companies in which there is a public interest in there being an audit. 91. As mentioned above, there is no general requirement in Ukraine Law for the approval of the appointment of independent auditors and the review of the independent audit report by the entity shareholders, supervisory board or audit committee.29 The auditors currently address the report to those with whom they have directly contracted (i.e. the Board of Directors, who are also responsible for the preparation of the financial statements). This close relationship between the independent auditor and the client, in terms of appointment and submission of reports, creates a threat to independence of the auditor and diminishes the reliance other stakeholders can place on the published audit report. Even though the threat is mitigated by the requirement to report to shareholders or their representatives any deficiencies identified during the audit, the auditor’s report should be addressed to the shareholders of the entity, not the management. 92. Enforcing auditing standards contributes to ensuring audit quality which in turn can add credibility to published financial information and act as an important protection mechanism for shareholders, creditors and other stakeholders. A proper and rigorous enforcement regime for financial reporting is critical to establishing and maintaining the quality of financial reporting and to underpinning confidence in local companies and financial markets. The 2002 and 2008 ROSC assessments noted that, while the regulators generally had sufficient authority to monitor compliance with legal and financial reporting requirements, they lacked the influence, resources and expertise to carry out their functions effectively. 93. While Ukraine has had a Law on Information since 1992, in reality, this framework does not facilitate public disclosure and access to information of public entities including SOEs. While both the Constitution and the law provide the right for citizen access to information, the law does not clearly articulate what information can be classified or how such a label can be applied to information so that it is not made available to the public. Even though information such as reports on the state budget’s incomes and expenditures should be publicly disclosed, the consolidated annual SOE report, which contains information on the aggregate financial results of the SOE sector including dividend transfers to the treasury, budget subsidies, and other fiscal related items, is not publicly disclosed. Moreover, SOEs are not required to publish annual financial statements (either in print, electronic or multi-media or other formats), and where an SOE may have been audited, the audit report is not disclosed to the public. Transparency and disclosure requirements are in need of significant strengthening and should first be clearly established in a modern legal framework. All large SOEs, with primarily commercially oriented operations, should be subject to the same rules as joint- 29 The only exceptions to this rule are banking institutions. 35 Assessment of Ukraine’s SOE Oversight System stock companies and be required to fully comply with national accounting standards, be subject to an annual external audit, and be required to disclose and regularly publish corporate results, performance and non-sensitive company information. The government should take measures to enforce the proper application of transparency and disclosure policies and ensure that public access to information is guaranteed. 94. For SOEs which can be classified as small and medium-sized enterprises, it will be essential to implement a simplified framework (e.g., with regard to performance management, requirements for transparency, reporting and disclosure, etc.), and which should be based on the same principles outlined for large SOEs. Given the considerable number of enterprises operating, this study could not evaluate the needs of a representative sample of companies to develop a detailed series of recommendations. As such, it will be important to consider the availability of existing tools and resources which can be easily applied at the enterprise level to improve internal management and organization, improve the quality of business plans and financial reporting, etc. SOEs falling into this category should, at a minimum, be required to develop clear operating objectives (including non-commercial or policy objectives if applicable), prepare an annual profit/loss statement (also called the income statement) and balance sheet, and be subject to a performance assessment focusing on basic financial results (e.g., profitability, asset turnover, debt/equity ratios). The IFC has supported the development of an on-line portal and tool-kit for Ukraine (www.vlasnasprava.info)30 where materials, “how-to� resources, business tools (including downloads for bookkeeping and cash management, technology products, operations management, etc.), advisory and other services are available. 30 Also see www.smetoolkit.org/smetoolkit/en for a link to the Ukrainian and other websites 36 Benchmarking Ukraine against the OECD Framework SECTION IV: BENCHMARKING UKRAINE AGAINST THE OECD FRAMEWORK 95. When assessing the performance of and considering any potential reforms for the SOE sector, it is useful to compare the current practices against well established and accepted benchmarks, as this allows for a better appreciation of the discrepancies and gaps observed in practice. 96. In this context, this section of the report analyzes Ukraine’s system of SOE corporate governance against the benchmark OECD framework. This section focuses on the most critical and essential areas (legal and regulatory framework; ownership policy; transparency and disclosure)31 for Ukraine to concentrate its efforts to further improve its system of SOE oversight and governance. These three areas are so closely intertwined and represent the fundamental building blocks for any reform initiative - these three areas reinforce each other and are part of an integrated set of principles which underpin any attempt to improve performance of SOEs. 97. Annex 4 provides a detailed point-by-point assessment of Ukraine’s system of oversight as compared to the complete OECD framework (six chapters). This section of the report also includes cases of internationally accepted good practice – from both industrialized and emerging market economies. GOOD INTERNATIONAL PRACTICE WITH REGARD TO SOE LEGAL AND REGULATORY FRAMEWORKS The legal and regulatory framework for SOEs should ensure a level-playing field in markets where state-owned enterprises and private sector companies compete in order to avoid market distortions. The framework should build on, and be fully compatible with, the OECD Principles of Corporate Governance (Chapter 1). 98. The state often plays a dual role of market regulator and owner of SOEs with commercial operations. Therefore, the full administrative separation of responsibilities for ownership and market regulation is a fundamental pre-requisite for creating a level playing field for SOEs and private companies and for avoiding distortion of competition. A separation of industrial policy and ownership enhances the identification of the state’s ownership role and favors transparency in defining SOE objectives and monitoring performance. 99. Many developing countries have undertaken numerous attempts to enhance SOE performance or restructure the SOE sector over the past several decades (through capital infusion, privatization, management performance incentives, etc.). Financial crises and difficult transitions to a market economy have also made clear the key role that corporate governance, which is established through a modern legal and regulatory framework, plays in enterprise reform. Today, improving corporate governance of SOEs is a stated policy objective in many countries around the world. 31 See chapters 1, 2 and 5 respectively of the OECD Guidelines. 37 Benchmarking Ukraine against the OECD Framework 100. The most common legal form of SOEs is the private limited liability company, followed by the joint-stock company. SOEs in the majority of OECD countries are subject to the same corporate regulations as listed private sector companies (on average, only about 10% of SOEs are listed companies in OECD countries32).33 While some countries (e.g., South Korea, Czech Republic, France) still classify SOEs under special legal categories (or SOEs are classified under special legal status), these examples are increasingly rare. What is notable, however, is that the legal and regulatory frameworks in these countries are based on modern corporate law and practices, and have incorporated many of the corporate governance principles outlined in the OECD framework. Good international practice shows that the same regulatory and legal framework should be applied evenly across all classifications of SOEs (including an SOE’s subsidiaries).34 Additionally, leading international practice demonstrates that the enforcement, by other governmental institutions (or branches of government), of the legal and regulatory framework is an equally essential component. 101. The legal framework for SOEs in Ukraine was originally rooted in the Commercial Code of Ukraine. While the Commercial Code defines the broad boundaries of the public sector, and includes SOEs as part of the responsibility of government oversight, the Code and other legislation (e.g., the 2006 Law “On Management of State Assets�) do not provide an adequate management and oversight regulatory framework as it does not prescribe or require specialized oversight or management but rather documents functions and procedures which have arisen spontaneously over time. Many important details of modern governance and oversight systems, including SOE disclosure requirements and public access to information, clear roles and responsibilities of the supervising Minister/Ministry, dividend policy, financial reporting and audit requirements, are currently excluded from Ukraine’s legal framework and what has been put into practice, differs significantly from international standards and benchmarks. 102. The legal framework in Ukraine weakens SOE oversight and accountability as these functions are effectively spread across a number of agencies. The dilution of government accountability or responsibility (as the owner of an SOE), in effect, results that no effective oversight is actually performed. The effective rules and regulations applicable to unitary and kazenni SOEs differ from those applied to SOEs which are also joint-stock companies or SOEs which are corporatized. 103. Additionally, the current legal framework is overly flexible with regard to the government’s role in providing SOE’s with more favorable access to financing (or terms of financing) and capital structure. The current law does not limit the state’s guarantee of SOEs liabilities nor does the law set minimum levels of creditworthiness in order for an SOE to access capital markets for lines of credit and other forms financing. Often, SOEs’ access to loans or other financial instruments is through state-owned banks, which can further increase the burden and effective liability of the government if SOEs are unable to maintain their financial integrity 32 See Chapter 1 of the OECD, Corporate Governance of State Owned Enterprises – A Survey of OECD Countries, 2005 33 See Chapter 1 of The Anatomy of Corporate Law – A Comparative and Functional Approach, Oxford University. 34 International experience does show that differentiation (or streamlining) of specific requirements, such as financial reporting standards, should be applied based on the size of an SOE. For example, small and medium sized SOEs should utilize the same financial reporting standards that are applied to private sector SMEs. 38 Benchmarking Ukraine against the OECD Framework and repay the banks. This practice clearly weakens fiscal discipline in SOEs. It also demonstrates the strong influence of the government in an SOE’s operations, which in turn actually undermines the government’s management and oversight responsibilities. 104. International Practices. The European Union (EU) has undertaken several recent measures to upgrade its framework regulating company law and approach to corporate governance – this applies both to listed companies and SOEs.35 While the national frameworks of member states are different, they do comply with a common set of corporate governance principles covering board composition and functions, board committees, transparency and disclosure, shareholders rights (including minority shareholders), and employee representation. The EU has undertaken several initiatives (developed an action plan in 2003 on Company Law and Corporate Governance, updated the action plan in 2006 with a focus strengthening shareholders rights, created the European Corporate Governance Forum in 2004 and updated several key Directives of the Company Law36) in recent years to address the issue disparate or lagging corporate (and SOE) practices among EU member states. The objective of the 2003 action on company law and corporate governance was to facilitate the harmonization of rules relating to company law and corporate governance, including accounting and auditing, in support of the Single Market for Financial Services and products.37 105. Additionally, a review of international practice indicates that some countries have created specific frameworks to align SOE practices with those of the private sector. South Africa initially developed the Companies Act to regulate SOE practices. In 1999, the country passed the Public Finance Management Act which aligned the standards of all public sector entities with relevant international benchmarks. Furthermore, in 2002, the Department of Public Enterprises of the South African government established a specific protocol for all SOEs to implement.38 While this protocol builds on prior legislation, its primary objective was to establish clear roles and functions, lines of accountability, obligations and requirements for both supervising government bodies as well as for SOEs. The protocol covers all areas of corporate governance – composition, appointment and function of an SOE Board (and its committees); remuneration and appointment policy of the CEO; financial, accounting and audit policy, including transparency and disclosure requirements, in-year reporting, SOE borrowing and state financial guarantees; and corporate ethics. 106. New Zealand, first developed the State-Owned Enterprises Act in 198639 and later updated the legal framework through the 1993 Companies Act and the 2004 Crown Entities Act. Like South Africa, the New Zealand framework details the full range of corporate governance roles, government oversight functions and responsibilities (including that of ministry supervision 35 In the EU law and accompanying directives, SOEs are referred to as public limited liability companies. 36 Relevant Directives of the Company Law which have been updated include: Accounting and Auditing Rules (2007), Transparency (2005), and Exercise of Shareholders Rights (2007). 37 European Commission-IFC, “The EU Approach to Corporate Governance�, Essentials and Recent Developments, February 2008. 38 The 2002 Protocol on Corporate Governance in the Public Sector, Department of Public Enterprises, Government of South Africa updated the first Protocol released in 1997. 39 New Zealand also had enacted separate legislation for noncommercial SOEs through the 1992 Crown Research Institutes Act. 39 Benchmarking Ukraine against the OECD Framework of SOE management and the role of Parliamentary oversight of the SOE and responsible Minister), requirements and functions of the board of directors, requirements for transparency and disclosure, conflict of interest, dividend policy, limitation of liability and tax policy. The New Zealand framework requires each SOE to be based on a founding constitution which sets the company’s objectives and missions. The country’s legal framework also sets requirements for each SOE to be financially viable (evidenced by through the issuance of at least a BBB credit rating by an independent rating agency40). 107. Canada, which recently conducted a review of its governance and accountability framework for Crown Corporations (SOEs), has had the legal framework for SOEs41 in place since 1984. The legal framework created a strong systemic oversight function for the supervising ministry. This required that the minister ensured that properly qualified and capable individual were appointed to the board of directors, that the SOE’s corporate plan and policy directions were aligned and that the SOE delivered on its mandate. Underpinning all of this is a strong regulatory (and legal) framework on financial reporting, independent (or external) auditing, transparency and disclosure, shareholder rights and a range of other corporate governance issues. The government further strengthened the SOE oversight function through the introduction of the 2003 Guidelines for Audit Committees of Crown Corporations and Other Public Enterprises.42 The 2005 review of the government’s governance and accountability framework identified five areas for further strengthening43 and resulted in the introduction of 31 specific reform measures. The key improvements to the framework included: (i) extending the Access to Information Act and the Financial Administration Act to all SOEs and subsidiaries; modification of the CEO appointment process by increasing the role of the board of directors vis-à-vis the government’s role; (iii) providing a greater role to the Parliament in vetting nominations and introducing a framework to ensure a merit-based process for the appointment of members to the board of directors; (iv) requiring that all government financial support to SOEs (including budget transfers, subsidies, guarantees, etc.) be made transparent and included in the budget submitted to Parliament; and (v) allowing the Auditor General of Canada (Supreme Audit Institution) to be named as the independent external auditor of an SOE and requiring the Auditor General to conduct a value-for-money audit, at least once every five years, of each SOE. EVOLUTION OF THE STATE OWNERSHIP FUNCTION The state should act as an informed and active owner and establish a clear and consistent ownership policy, ensuring that the governance of state-owned enterprises is carried out in a transparent and accountable manner, with the necessary degree of professionalism and effectiveness (Chapter 2). 40 2007 Manual for State-Owned Enterprises, CCMAU and Treasury of New Zealand 41 Financial Administration Act 42 The Guidelines include not only the functions of the committee, but also a requirement on the technical financial management and accounting qualifications (experience and knowledge) of audit committee members. 43 (i) Clarifying the relationship between ministers and SOEs and who is accountable to Parliament; (ii) strengthening the accountability regimes of SOEs; (iii) making the process of appointment of the CEO and board of directors more transparent; (iv) strengthening the SOEs’ audit regimes (including internal audit) and (v) making SOE operations more transparent. 40 Benchmarking Ukraine against the OECD Framework 108. An effective ownership policy addresses key challenges of SOE corporate governance. In establishing its ownership policy, the state should ensure, that regardless of the ownership model or form, that it establishes and practices an arms-length relationship vis-á-vis its enterprises and assets. The functions of an effective state ownership policy include (i) a clear dividend and investment policy for all SOEs; (ii) a monitoring and evaluation framework, which is frequently practiced through the issuance of management performance contracts; (iii) enforcement mechanism, including clear accountabilities and consequences for non-compliance. As evidenced by numerous examples of successful country reform, an improved ownership policy and function places greater importance on the appointment of qualified and professional SOE managers and members of the board of directors.44 109. The ownership function for SOEs can essentially be classified in three different models. The decentralized model, where state-owned enterprises are under the responsibility of relevant sector ministries, has been the tradition used in many OECD countries. This decentralized model was most prevalent in socialist economies prior to their transition to a market economy. The dual model is, however, the most prevalent one, where the responsibility is shared between the sector ministry and a “central� Ministry or entity, usually the Ministry of Finance or the Treasury. Finally, a centralized model, in which the ownership responsibility is centralized under one main ministry, has been on the increase more recently. The evolution and reform of the organization of the ownership function have been significant in the last two decades, and a number of countries are still undertaking reforms. These reforms tend to move countries away from the decentralized model and more towards the centralized model. 110. As seen through international experience, there were several disadvantages with the decentralized model. First, there was a difficulty in separating the state’s ownership and regulatory (including industrial policy) functions. The move towards a centralized model of ownership has been largely driven by the effort to devolve regulatory oversight to more specialized institutions while focusing state ownership on maximizing shareholder (state) value. Second, in a decentralized model it was difficult to determine who exactly is running a SOE’s operations. It was commonly perceived that line ministries were heavily involved in the daily operations of an enterprise – which underscored the belief of high levels of government and political interference in a SOE’s commercially-oriented operations. 111. The underlying rationale for the reform of the ownership function is the need to complement the structural reforms of the past two decades in many sectors in which SOEs are still prevalent in many OECD countries. This is particularly the case in non-manufacturing sectors (such as gas and electricity supply, telecoms, postal services, air transport, railways), where access or price regulation is still needed due to the technological or informational characteristics of such industries. Structural reforms in these sectors have included widespread privatization and regulatory reforms. 112. Regulatory reforms have been extensive, involving increased international openness, easier entry to domestic markets, and an increased reliance on market-based and/or incentive mechanisms. The progress in reforming the regulation of non-manufacturing industries has been 44 Corporate Governance of State Owned Enterprises – A Survey of OECD Countries, 2005 41 Benchmarking Ukraine against the OECD Framework significant in the 1990’s in most OECD countries. This progress has been particularly important in network industries (telecoms, utilities and air transport), although the timing and scope differs across OECD countries. These reform efforts are continuing in some industries especially in the EU as part of the drive to complete an open internal market. Most OECD countries have progressively separated clearly the regulatory function within the state administration, mainly to ensure a level playing field between state-owned and privately owned companies. The state is now reforming its ownership function in order to more clearly identify and strengthen this function, as well as to reinforce the incentives for SOE management and boards to produce efficiently and compete effectively. 113. Most SOEs pursue multiple, and sometimes conflicting, objectives. The multiple objectives arise either because they are mandated by legislation or because different government ministries are in a position to exert strong influence on the SOE’s operations and mandate. However good international practices show that a SOE will clearly declare is business objective through a company mission statement or other authoritative and publicly disclosed document. An important function of the government’s ownership function (and a key component of its oversight role, usually through the managing ministry or specialized agency) is to ensure that the SOE’s business objectives align closely with national economic interest and development priorities. 114. Ukraine deviates from the good practices presented above. It does not have a clear and consistent ownership policy. Although the government’s dividend policy is developed in conjunction with budget formulation, evidence suggests that there is weak or inconsistent enforcement to ensure that required dividends are remitted to the treasury. While the Law “On the Management of State Assets� was recently enacted, it does not prescribe any specialized management functions or provide a robust framework for oversight. The system of SOE performance evaluation is largely a self-assessment, is not consistently applied and there is little evidence to suggest that the supervising ministry takes meaningful action. 115. Ukraine’s current SOE ownership function follows essentially a decentralized model. While the CMU is granted broad power and responsibility for oversight, it delegates this function to the MOE, SPF and line ministries. Given that there are more than 3,500 SOEs currently operating45, it is extremely challenging for the government to effectively manage and oversee such a large portfolio. Thus it is more difficult for the government, acting in its ownership capacity, to assess SOE performance as the SOE’s operating objectives are unclear (even in cases where an SOE has established its objectives, this information rarely is made available to the public). 116. Where an SOE has special responsibilities or obligation to fulfill (e.g., in providing a unique service or function to benefit the public), this should be clearly rooted in law/regulations, incorporated into the enterprises by-laws, and disclosed to the public – including any potential impact on the SOE’s resources and economic performance. For those SOEs in Ukraine with commercial operations and which are competing with private sector enterprises, there is a need to require each SOE to clearly articulate its business objectives. This would enable a better 45 This figure does not include municipal or communal SOEs operating under the supervision of local government. 42 Benchmarking Ukraine against the OECD Framework assessment of company performance as relevant benchmarks can be established (apart from improving the overall performance framework, which is also needed). 117. Good International Practices. In many former transition economies, centralization of the ownership function meant not only an efficient means to support privatization, but to distinguish from past behavior where the state was involved in very close management of SOEs. Over a period of fifteen years, Poland undertook a series of steps to separate the ownership and regulatory functions creating distinct units responsible for privatization and corporate governance (management and oversight). In clarifying the ownership policy, the government’s revised framework decided that the function of state ownership would be discharged through the government’s representation on SOE supervisory and executive boards. The Ministry of State Treasury was designated as the primary agency responsible for executing the government’s ownership function – eliminating the previously divided responsibility with line ministries that had been shared but ineffectively implemented. In upgrading the corporate governance, transparency and disclosure framework, in October 2005, the government issued a revised set of regulations46 (developed by the Ministry of State Treasury), embedding the full range of the OECD SOE Corporate Governance principles. This approach demonstrated the inherently close link between state ownership policy and SOE corporate governance in order to implement an effective system of oversight. 118. Following a specialized report commissioned to review the state ownership47, in 2004 France established a new centralized agency (Agence des Participation d’Etat) to assume the responsibility for oversight and management of the country’s SOEs. The Barbier de la Serre report offered a series of recommendations (which have since been implemented) to clarify and strengthen the state’s ownership functions, among them: (i) clearly distinguish the regulatory and ownership roles through separating the functions and placing them in separate agencies/departments; (ii) improve the ownership function by establishing a dedicated entity to improve strategic thinking, transparency and to reinforce the role of SOE boards; (iii) improve accountability to the public and Parliament through regular reporting on the performance of the SOE portfolio and (iv) protect the interests of minority shareholder. With regard to the newly created entity, the responsibilities conferred to 119. Until recently, New Zealand had considerable success in utilizing the dual model of state ownership. While the Ministry of Finance focuses on the fiscal impact and economic efficiency of SOE performance (i.e. the company’s balance sheet and fiscal position), the Treasury Advisory Unit, CCMAU (Crown Company Monitoring Advisory Unit), is focused on ensuring that SOEs are profitable and successful companies (i.e., performance, commercial environment, enterprise risk management)48. CCMAU, and the sector ministries, take the lead to actively monitor and oversee company performance, among other responsibilities including the appointment of members of board of directors. However, due to several years of underperforming state assets, the government of New Zealand in November 2009 disestablished 46 This is commonly known as the Ministry of State Treasury Principles 47 2003 Barbier de la Serre Report, commissioned by the Ministry of Finance of France 48 2007 Owner’s Manual for State-Owned Enterprises, CCMAU and the Treasury of New Zealand. 43 Benchmarking Ukraine against the OECD Framework this advisory unit and re-centralized the functions and responsibility for management/oversight of SOEs transferring them back to the Treasury.49 120. In 2001, Indonesia established a central ministry (Ministry of State-Owned Enterprises) and over a three year period, implemented a series of significant reforms to simultaneously strengthen the oversight/ownership function as well as implement a modern framework of SOE corporate governance practices for the enterprises which were not subject to privatization. There were important achievements realized at the end of this initial three year reform initiative, including: (i) the establishment of a sound policy, legal regulatory and operational SOE frameworks which underpinned improving corporate governance practices; (ii) transparent and proper fiscal treatment of SOE’s public service obligations; (iii) improved financial performance as a result of implementing modern corporate governance practices, standards and codes; (iv) improved transparency and disclosure of SOE objectives and performance/results; and (v) gradual divestment of state shares in 15 SOEs resulting in significant budgetary inflows to the national treasury.50 TRANSPARENCY AND DISCLOSURE State-owned enterprises should observe high standards of transparency in accordance with the OECD Principles of Corporate Governance (Chapter 5). 121. Transparency is a cornerstone of any governance reform. Open or public access to information establishes the basis for accountability. Without accurate and detailed information it is difficult to set targets, allocate resources efficiently and assess company performance. In almost all OECD countries, SOEs follow the regulatory provisions of the company commercial code, Company Law, listing requirements and/or corporate governance principles/codes. It is in the state’s interest that other shareholders do not perceive it as an opaque or unpredictable owner. Good corporate governance must be seen to be practiced, which is done through compliance with high standards of disclosure. 122. Apart from the requirements for SOEs to be transparent and publicly disclose financial and operational performance reports, governments themselves should also adopt more transparent practices. In many OECD countries, governments publicly disclose guidelines for SOE oversight - including how and when the government intervenes into SOE operations. Governments should also publish the objectives and goals for SOEs along with the periodic assessments on SOE performance in an effort to build public confidence. 123. The OECD guidelines note three distinct but inter-related types of SOE reporting which contribute to improving oversight and governance: (i) ex-ante, (ii) ex-post and (iii) aggregate reporting. While ex-post reporting is common between SOEs and listed companies, ex-ante and 49 The functions of CCMAU, formerly an independent quasi-governmental agency, have been transferred to the Crown Ownership Monitoring Unit (COMU) within the New Zealand Treasury. 50 2009 “Indonesia State-Owned Enterprise Governance and Privatization Program’� Asian Development Bank Independent Evaluation Report 44 Benchmarking Ukraine against the OECD Framework aggregate reporting are unique to the SOE sector – though aggregate reporting is rare even among OECD countries. • Ex-ante reporting is in addition to the basic reporting requirements as set in the Company Law, and is primarily focused on setting clear objectives and performance targets. This is commonly found through management performance contracts or statements of corporate intent (SCI). • At a minimum, timely and full ex-post disclosure requirements (usually through the issuance and publication of an annual report) should include, inter alia: (i) statement of company objectives, including public policy/social or non-commercial objectives; (ii) financial performance and financial statements with clear explanations of unusual transactions; (iii) total compensation of all directors and management, including board members; (iv) details of major events and changes which materially impact its results; (v) auditor report; and (vi) minutes from shareholder/annual meetings. In OECD countries, SOEs are increasingly reporting (ex-post) in as much detail as joint-stock and listed companies. • Aggregate reporting covers all forms of reporting on the overall sector and is usually done by the supervising ministry, supreme audit institution or other oversight body. This form of reporting aims to inform the Parliament and general public of the performance and annual results of the SOE portfolio. 124. In most OECD countries, SOEs are required to apply the same accounting and financial reporting standards used by listed companies. This is predominantly International Financial Reporting Standards (IFRS) as many countries have converged national standards with the international benchmark. Likewise, in most OECD countries, SOEs are subject to the same audit requirement as listed companies (audits based on International Standards of Auditing or ISA). This requires that the company’s financial statements are audited by a qualified external audit firm providing assurance that the financial statements are free from error or misrepresentation. In many countries, the selection auditors of SOEs is endorsed (if not chosen directly) by the SOE’s board of directors. 125. In Ukraine, while joint-stock and listed companies are subject to stricter financial reporting and audit requirements51, unitary SOEs are not required to produce financial statements based on international standards. Furthermore, unitary SOEs are not required to be audited on an annual basis. More often than not, SOE financial information is not publicly available – neither through a central repository (e.g., Ministry of Economy) nor through an enterprise’s own website. 126. SOEs in Ukraine which are joint-stock companies follow the Law on Accounting and use National Accounting Standards (NAS) as the basis to prepare their financial statements. While there is a higher degree of transparency with regard to reporting requirements for joint-stock 51 The 2008 Law of Ukraine On Joint stock Companies No. 514-VI, the 2006 Law of Ukraine On Securities and Stock market No. 3480-IV and the 1996 Law of Ukraine On State Regulation of Securities Market in Ukraine No. 448/96-BP. 45 Benchmarking Ukraine against the OECD Framework companies as compared to unitary SOEs, the 2008 Accounting and Auditing ROSC study found not only significant differences between NAS and IFRS, but also significant issues related to the lack of compliance with NAS52. While Ukraine’s NAS had largely been based on IFRS, the key differences were that NAS do not entirely reflect the latest developments in IFRS and the disclosure requirements of NAS are less demanding than IFRS. The result of the material differences between the two standards makes comparability of financial statements difficult. The MOF has recently (November 2010) taken several steps to upgrade NAS and to eliminate the remaining differences with IFRS. Furthermore, there is limited usefulness of financial statements to professional users of financial information with limited knowledge of Ukrainian NAS.53 127. Additionally, the 2008 Accounting and Auditing ROSC study note that many SOEs have rudimentary accounting and reporting systems and lack capacity to apply NAS and produce financial reports. Consequently, the quality of financial information produced by SOEs varies significantly and often inadequately reflects the economic and financial performance of the company. Unitary and kazenni SOEs, which lack a corresponding incentive to produce or lack the demand for reliable and comprehensive financial reporting and disclosure, merely submit the required financial data and self-reported indicator to the supervising line ministry and produce information for the state tax administration. 128. International Developments and Practices. As noted earlier in this section, the European Union has undertaken several recent initiatives to upgrade its financial reporting and accountability framework. In the context of Transparency and Disclosure requirements, the EU has prepared a special paper54 proposing to incorporate additional dimensions of corporate governance into EU company law, broaden the coverage of governance issues into the external auditor’s framework, and upgrade disclosure requirements (particularly with respect to the functions of the board of directors or supervisory board55). 129. OECD countries, in addition to strengthening their financial reporting architecture, have responded to recent crises (e.g., notable international cases of accounting scandals such as Enron, Siemens, Société Générale) to further upgrade their corporate governance frameworks and to include an annual disclosure of a company’s compliance with national law. Increasingly, listed companies as well as SOEs are required to issue a formal Corporate Governance Statement in the annual report (some countries require a separate Corporate Governance Report to be issued annually). The content of this additional disclosure and reporting includes information on: (i) board composition and nomination process; (ii) resources available to directors for external advice or high-level/executive advisory services; (iii) procedures for elaborating and reviewing compensation schemes for the CEO and board members; (iv) procedures for nominating/contracting external auditors; (v) enterprise risk management and (vi) ethics policy. 52 Significant findings of non-compliance with NAS included: (i) non-disclosure of related party transactions; (ii) non-disclosure of accounting policies adopted; (iii) failure to include cash flow statements; (iv) assets carried at historical cost despite evidence of impairment; (v) non-disclosure of earning per share 53 2008 ROSC Accounting and Auditing. 54 Discussion Paper for Auditor’s Role Regarding Providing Assurance on Corporate Governance Statements, Federation of European Accountants, Brussels, November 2009. 55 In some European countries, the Supervisory Board is part of a two-tier oversight system and is placed organizationally, between the Executive Board and Management. 46 Benchmarking Ukraine against the OECD Framework Good Practices in Ex-Ante Reporting 130. SOEs in Korea are required to submit the “Report on Actual Results of Operation� with financial and non-financial information on the SOE’s objectives, as well as “concerns of public interest�. This report is submitted to all supervising entities (e.g., line ministry, Ministry of Finance, etc.) and the National Assembly (Parliament). 131. In Australia, all SOE develop a Statement of Corporate Intent which is used as planning and accountability document specifying financial and non-financial performance targets for the subsequent three year period. The purpose of this document is to enhance ex-ante accountability and to provide clarity as to the SOE’s mandate and objectives. 132. In New Zealand, the management and boards of SOEs develop a strategy and financial performance plans (including targets and performance indicators) for a three year period – and which is captured in the Statement of Corporate Intent. These statements of intent establish the scope and nature of the SOEs activities and operations and are used as a reference document against which SOE boards (and management) are held accountable. 133. In Poland, the Ministry of Treasury prepares an annual “Report on the Economic and Financial Conditions of State Assets� which is submitted for Parliamentary review and approval. Good Practices in Ex-Post Reporting 134. While a country may impose specific and unique requirements for SOE ex-post reporting, overwhelmingly there are numerous similarities and common principles observed across countries. Financial reporting (including accounting policies and standards) should comply with international standards and all but the smallest SOEs should produce and public disclose accurate annual financial reports. SOEs should also report on non-financial information including related party transactions (especially transactions with other SOEs), changes in board membership and company management, and changes in ownership structure. Typically the audited financial statements are included in the SOE’ Annual Report. As part of the annual reporting obligation, many countries require the inclusion of performance indicators which attempt to reconcile with the company’s objectives and targets as reported ex-ante. 47 Conclusions and Recommendations CONCLUSIONS AND RECOMMENDATIONS 135. The global and economic crisis has hit Ukraine particularly hard as GDP contracted 15 percent in 2009. State-owned enterprises continue to represent a significant share of Ukraine’s economy (particularly rail, transport, utilities, energy and telecommunications), and the crisis further expanded the public sector through nationalization and state recapitalization of banks. As fiscal measures continue to increase, rationalization and improved allocation of fiscal resources has become a priority. 136. While the government of Ukraine has taken some measures to improve its system of management and oversight of state-owned enterprises, several fundamental issues remain unresolved and which continue to limit the effectiveness and efficiency of the government’s oversight function. This paper analyzed the current system of SOE oversight with an objective to propose measures to align Ukraine’s system with international benchmarks, standards and good practices. 137. Summary of Findings. Ukraine’s SOE sector has a wide range of ownership and management schemes. The basic legal framework for SOE management and oversight, defined in the Commercial Code of Ukraine, provides for the delegation of responsibilities across several ministries/agencies. As a result, there are overlapping roles across different government institutions, and gaps with regard to active monitoring and oversight. 138. In practice, the SOE oversight function of the line ministries is primarily exercised through a review of the reports submitted by the SOEs on the implementation of financial plans. However, the review is typically light. And its efficiency is undermined by the limited clarity of the operating objectives for SOEs, and limited usefulness of the performance management framework. Moreover, the underlying data used to measure performance indicators is not validated and its reliability is uncertain. Even though the current performance management framework can be improved, performance evaluations are not conducted for a substantial number of SOEs which seriously undermines the effectiveness of management and oversight. 139. Transparency and disclosure requirements are in need of significant strengthening and should first be clearly established in a modern legal framework. Many of the deficiencies in Ukraine’s current financial reporting architecture, in particular incomplete consolidations and the absence of appropriate or complete disclosures relating to related parties and owners, make it difficult for users to make a proper assessment of the financial position and performance of an SOE. There is no requirement for entities to be subject to an annual external audit. Additionally, SOEs are not required to disclose or publish basic financial information, corporate results, or other non-sensitive company information. There is also a need to enforce the proper application of transparency and disclosure policies and ensure that public access to information is guaranteed. 48 Conclusions and Recommendations 140. Recommendations. The recommendations focus on three interrelated and critical areas which underpin any effort to reform or improve SOE performance: (i) legal framework, (ii) state ownership policy, and (iii) transparency and disclosure. A strong legal framework not only requires the implementation of modern corporate governance practices within an enterprise, but it also supports the development of clear objectives and goals against which performance can be objectively measured. In trying to improve the performance of SOEs, it is also necessary to ensure that they are insulated from political interference, clarify the government’s oversight and monitoring role, and establish an arms-length relationship between government and SOEs in terms of managing an enterprise’s. Lastly, transparency is the cornerstone of any governance reform and open access to information provides the basis for accountability and enhances the ability to assess performance and allocate capital and resources effectively. 141. First and foremost, there is an urgent need to establish a single and comprehensive database or registry of all SOEs operating in Ukraine. The fact that such a system or registry does not fully exist is not only worrisome but also demonstrates that the difficulty in trying to obtain complete data on the SOE sector or even information on a specific enterprise. 142. Second, once a complete enterprise database is established, it would be important to segment the sector – distinguishing large SOEs from small and medium enterprises. While this is apparently contemplated in the CCU (Article 63, part 7), an alternative and practical approach would be to apply the methodology used by the International Federation of Accountants (IFAC), which is the global standard setting body for accounting, auditing and financial reporting standards, including IFRS. This would allow the government to initially focus its attention and efforts to improve the performance of those enterprises, whose mandate and nature of activities are commercially oriented, which represent either significant value to the economy (or to a specific sector) or which represent significant risk (e.g., fiscal risk) to the government. 143. Third, all large SOEs (which are primarily commercially oriented) should be subject to process that utilizes the principles of corporatization with a clear purpose to improve the enterprise’s internal management structures. This effort would also include strengthening internal controls, and modernizing (or implementing) operational and risk management systems and practices. For all large SOEs, the primary oversight function should be delegated to autonomous, professional and competent boards of directors. 144. Legal Framework. While there have been recent advances in improving the legal framework for SOEs which are joint-stock companies, there is a need to modernize and upgrade the legal framework for unitary and kazenni SOEs. In revising the legal framework for SOEs, it is advisable to establish a single, unifying and basic set of regulations which would be applied evenly across all sectors. This effort should strive to reduce, or eliminate entirely, the current differences between regulations applicable to joint-stock companies and those which apply to unitary and kazenni enterprises. It is also important to simultaneously better define what the role of government oversight entail as well as clarify which government ministry/agency is responsible for a specific function. The legal framework should establish a clear arms-length relationship between government and an SOE and should include specific limits on the government’s role or influence regarding an SOE’s access to finance and credit. Modern 49 Conclusions and Recommendations corporate governance practices (including establishing independent and professional boards of directors, including board committees for all large SOEs) should be integrated into the revised and upgraded framework. Lastly, SOEs should be required to establish clear operating objectives as this would establish the basis on which performance can be objectively evaluated. 145. State Ownership Policy. Ukraine has essentially relied on a decentralized model of ownership. Though given the sheer number of SOEs operating in the country this approach conceptually is valid, it has resulted in a dilution of basic responsibilities and effectively, little oversight is actually performed. 146. In revising the state’s ownership function, which should be underpinned by a strong corporate governance framework, the government of Ukraine should first develop a clear ownership policy which separates the regulatory function from management and oversight, and which provides the general public with a clear understanding of the state’s objective as an owner. In attempting to strengthen accountability, the government, as the ultimate guarantor of SOE debt and liabilities, should develop clear limits with regard to its financial obligations and exposure. There should also be clear criteria which would help evaluate SOE proposals or requests to access financial instruments. 147. While Ukraine has implemented a performance management framework, there is a need to improve both the quality of indicators as well as the quality of information used for measurement. Moreover, given that there are significant gaps in compliance with performance evaluations and even with remittance of dividends to the national treasury, it will be important to develop mechanisms by which to better monitor and enforce compliance with these requirements. 148. While KRU is currently implementing a series of reforms to align with the EU model of internal audit, its role with respect to conducting inspections and audits of SOEs should be carefully revised to ensure it will be compatible with its new organizational form and mandate. Additionally, the government should seek to strengthen the role of the Accounting Chamber (Ukraine’s SAI) by empowering it to regularly audit (or sub-contract such audits to private sector audit firms) at least the largest SOEs on a periodic basis. The scope of its work should not be limited to reviewing compliance with budgetary regulations and directives but rather it should be focused to conducting comprehensive financial or performance audits of the enterprise, including its subsidiaries. 149. Transparency and Disclosure. There is a need to significantly strengthen basic transparency and accountability requirements and practices for all SOEs. SOEs should be required to ex-ante publicly disclose/publish the enterprise’s operating objectives (including both commercial and non-commercial objectives) as well as financial plans. The government should also be required to publicly disclose the annual reports on SOE performance – both in aggregate as well as for individual enterprises. 150. Large SOEs (whose business activities are commercially oriented) should be required to fully comply with Ukrainian National Accounting Standards (NAS), including with respect to standards on disclosure, related party transactions, asset valuation, contingent liabilities, etc. The 50 Conclusions and Recommendations introduction and application of IFRS should remain as a medium to longer term objective. SOEs which can be classified as small and medium-sized enterprises (SMEs) should be allowed to take advantage of reduced accounting requirements. Large SOEs should also be required to report comprehensively, including consolidation of financial information for its subsidiaries. Upgrading the underlying standards of financial reporting would also significantly help improve the reliability and usefulness of data used for performance measurement. The current draft Law on Accounting, which covers the standards and practices for the private sector, should be amended to also include this category of SOEs. 151. All large SOEs should have their financial statements audited by statutory auditors in accordance with International Standards on Auditing (ISA) – and all SOEs should be subject to some form of independent annual financial audit. Over a 5 year period other entities could be brought within the scope of a required ISA-compliant audit, but the number of audits required should not exceed the potential capacity of the audit profession in Ukraine to provide ISA- compliant quality audit services. The audit requirement would also help to ensure that company financial data and results, which are used for performance measurement, is validated and reliable. The draft Law on Auditing should be amended as to also incorporate SOEs within its scope and regulation. 152. In terms of disclosure, all SOEs, especially the large SOEs, should be required to make their audited financial statements publicly available in a timely manner. There is a need to significantly strengthen and enforce compliance with the Law on Information to ensure that the general public, including interested users of financial information, has unrestricted access to company information that is not determined to be commercially sensitive. 153. The recommendations described above are consistent with prevailing international standards and practices. In particular these standards and practices are endorsed by the OECD and have been incorporated into the EU’s body of law and regulations. Implementation of these recommendations will bring Ukraine’s statutory framework into much greater alignment with the acquis communautaire. The EU’s Second, Fourth, Seventh and Eighth Company Law Directives and the Transparency Directive should be taken as examples to guide amendments to legislation, but the specifics of Ukraine’s environment should also be considered. The process of reform should be seen as part of the cooperation of Ukraine with the EU envisaged as part of the European Neighborhood Policy, and support for the reform can be sought from the international community supporting Ukraine’s development agenda. 154. In attempting to tackle the range of issues and problems posed by the overall SOE sector, the government may wish to consider a sequencing of activities. This could approach can be considered as platform or process through which momentum can be built and sustained in order to confront the more complex and difficult challenges. 51 Conclusions and Recommendations BOX 5: SEQUENCING OF REFORMS Short-term ƒ Establish a single and comprehensive database of all SOEs (including their financial indicators, assets and liabilities) which would enable a segmentation of the SOE sector into more manageable sub- sectors ƒ Develop and implement a plan of corporatization of large SOE (natural monopolies) as a way to improve overall quality of operations and to enable them to attract private capital and joint venture opportunities ƒ Require all large SOEs to be subject to an annual independent or external financial audit and to publish their annual reports, including the results and opinion of the annual audit ƒ Require all large SOEs to publish their operating objectives, including non-commercial objectives ƒ Amend the existing performance management framework, and accompanying underlying requirements and regulations, to incorporate standard measures and methodologies for the assessment of SOE performance ƒ Develop and implement a fiscal framework for SOEs to establish a level-playing field for access to credit and to be applied to assess an enterprise’s request to access loans, guarantees and other financial instruments Medium to longer-term ƒ Require all small and medium-sized SOEs to publish their operating objectives, including non- commercial objectives, as well as annual reports and financial results ƒ Incorporate the requirement that all SOE non-commercial or policy objectives be fully disclosed and financed by the state budget ƒ Develop a clear and comprehensive state ownership policy which devolves the close supervision of SOEs to Boards of Directors (for large SOEs) and allows the government to focus on monitoring overall performance of the SOE sector and its compliance with laws and regulations ƒ Develop a framework to establish the creation of professional and independent Boards of Directors, including board committees, for all large SOEs ƒ Implement and enforce the Law on Auditing, which now incorporates large SOEs within its scope ƒ Implement and enforce the draft Law on Accounting to require all large SOEs to apply IFRS in the preparation of their annual financial statements ƒ Implement a framework for the competitive selection of professional management for SOEs – similar to the recent framework enacted for joint-stock companies 52 Annex 1 ANNEX 1: SOE LEGAL FRAMEWORK AND REGULATIONS A. General Laws (Applicable to all SOEs) ´  1. Law of Ukraine. “On Privatization of State Property�. (“ 2. Law of Ukraine “On Property�. 7 February, 1991. #697-XII. (last amended: 21 January, 1995). 3. Law of Ukraine “On Enterprises in Ukraine�. Last amended: February 7, 2002. ¶  4. Law of Ukraine “On List of State-Owned Legal Entities, That Are not Subjects to ´ . July 7, 1992 (last amended: February 7, 2002). #847-XIV. Annex: List Privatization� (³ ´ , September 19, of State-Owned Legal Entities, That Are not Subjects to Privatization. 5. Law of Ukraine “On Companies� (³ 1991 (last amended: March 7, 2002). #1576-XII. B. Laws Applying to Non-incorporated State-Owned Proprietorships 1. Law of Ukraine “On Property�. 7 February, 1991. #697-XII. (last amended: 21 January, 1995). 2. Law of Ukraine “On Enterprises in Ukraine�. Last amended: February 7, 2002. 3. Law of Ukraine. July 7, 1992 (last amended: February 7, 2002). #847-XIV “On List of ¶  ´ . Annex: List of State- State-Owned Legal Entities, That Are not Subjects to Privatization� (³ Owned Legal Entities, That Are not Subjects to Privatization.  4. Cabinet of Ministers. Decree. 15 December, 1992. #8-92. “On Management of National Property� (³ “). 5. Cabinet of Ministers. Resolution. 19 March, 1993. #203 (last amended: 25 July, 2001).  “On Application of Contract with Head of State-Owned Enterprise� (“ ´  6. Cabinet of Ministers. Decree. 10 May, 1993. #48-93. “On Order of Income Disposal of  ´  State Enterprises, Establishments and Organizations� (³ 7. Cabinet of Ministers. Resolution. May 19, 1999. #859. “On Conditions and Amounts of  Wages for Heads of State and Communal Enterprises and Mergers of State Enterprises�   ¶ ´  (“ “On Typical Form of Contract with Head of Non-Incorporated SOE� ³ 8. Cabinet of Ministers. Resolution. August 2, 1995 (last amended: July, 26, 2001). #597.  ´  Annex: Typical Form of Contract with Head of Non-Incorporated SOE. 53 Annex 1 9. Ministry of Economy, Ministry of Labor and Ministry of Finance, State Property Fund of ´ . May 10, 1993. #43. Ukraine. “Typical Statute of Non-Incorporated State-Owned Proprietorship� (“ 10. Ministry of Economy. Decree. December 25, 2000. #277. “On Approval of Regulations towards Order of Annual Financial Plan Composition by SOE� (“ ´  Annex: Financial Plan of SOE. 11. Ministry of Industrial Policy of Ukraine. Decree. 26 July, 1999. #272. “Order of Contract Approval with Heads of Non-Incorporated , Kazenni and Communal SOEs and Their   Mergers, That Are Subordinated to the Ministry of Industrial Policy� (“   ¶   ´ 12. Ministry of Industrial Policy of Ukraine. Decree. 28 March, 2002. #138. “On Amendments to Form of Contract with Heads of Companies, Organizations and  ´  Establishments� (“ C. Laws Applying to Kazenni SOEs 1. Law of Ukraine “On Enterprises in Ukraine�. Last amended: February 7, 2002. 2. Cabinet of Ministers. Resolution. 22 July, 1998. #1129. “On Some Issues of Management ´ . Annex: Form of Financial Plan for Kazenni State-Owned of Kazenni State-Owned Proprietorships� (³ Proprietorship). 3. Cabinet of Ministers. Resolution. 30 June, 1998. #987 (last amended: October 15, 2001). ´  Annex: List of SOEs, which are to be converted “On Conversion of Non-Incorporated SOEs into Kazenni SOEs� (³ into Kazenni SOEs. ´  Annex: 4. Cabinet of Ministers. Resolution. 18 June, 1998. #914. “On Typical Charter of Kazenni State-owned Proprietorship� (³ Typical Form of Charter of Kazenni State-Owned Proprietorship. 5. Ministry of Industrial Policy of Ukraine. Decree. 12 October, 1998. #371. “On Approval ´  Annex: of Contract Form with Head of Kazenni State-Owned Proprietorship� (“ Form of Contract with Head of Kazenni State-Owned Proprietorship; Form of Report of Head of Kazenni State-Owned Proprietorship 6. Ministry of Industrial Policy of Ukraine. Decree. 28 March, 2002. #138. “On Amendments to Form of Contract with Heads of Companies, Organizations and  ´  Establishments� (“ 7. Ministry of Industrial Policy of Ukraine. Decree. 26 July, 1999. #272. “Order of Contract Approval with Heads of Partially, Kazenni and Communal SOEs and their Mergers, That    Are Subordinated to the Ministry of Industrial Policy� (“ 54 Annex 1  ¶   ´ D. Laws Applying to Fully State-Owned Companies 1. Law of Ukraine “On Companies� (³ ´ , September 19, 1991 (last amended: March 7, 2002). #1576-XII. ´ . 2. Presidential Decree June 15, 1993 (last amended: August 28, 2001). #210/93. “On Incorporating of Companies� (³ 3. Presidential Decree “On Drastic Measures on Ordering of Activities of Fully State- Owned Corporations and State Holding Companies�, November 7, 2001. #1049/2001. Annex: List of Fully State Owned Corporations and State Holding Companies. 4. Cabinet of Ministers. Resolution. 5 July, 1993. #508 (last amended: 22 April, 1997). “On ´  Approval of Regulations towards Order of Incorporating of Companies� (³ 5. Cabinet of Ministers. Resolution. 19 July, 1993. #556 (last amended: 7 February, 2001). ´  “On Approval of Regulations towards Board of Directors� (³ 6. State Property Fund of Ukraine. Order. April 6, 2000 (last amended: June 15, 2001). #695. “On Approval of Regulations towards Order of Negotiation or Re-negotiation of Contract with CEO of Open Joint Stock Company, Holding Company and Fully State- Owned corporation and Typical Form of Contract with CEO�. ( “  ´). Annex: Typical Form of Contract with CEO. 7. State Property Fund of Ukraine. Ministry of Economy of Ukraine. Order. June 25, 2001 (last amended: October 15, 2001). #1129/134. “On Approval of Typical Charter of Open Joint Stock Company, Created by Incorporating of State Enterprise, Not Subject to   Privatization�. (“ ´  Annex: Typical Charter of Fully State-Owned Corporation�. 8. State Property Fund of Ukraine. Order. February 21, 2002. #343. “On Approval of Form of Financial Plan of Corporation, More Than 50% of Shares of Which Is Owned by State and Methodological Recommendations on Order of Composition and Approval of   Annual Financial Plan� (“ ´ . Annex: Financial Plan of Corporation, More Than 50% of Shares of Which Is Owned by State. 9. Ministry of Finance. Order. August 21, 1996. #172. “On Approval of Order of Inflow to   Budget of Dividends from State-Owned Shares�. (³ ´ . E. Laws Applying to State Holding Companies 55 Annex 1 1. Law of Ukraine “On Companies� (³ ´ , September 19, 1991 (last amended: March 7, 2002). #1576-XII. 2. Presidential Decree “On Drastic Measures on Ordering of Activities of Fully State- Owned Corporations and State Holding Companies�, November 7, 2001. #1049/2001. Annex: List of Fully State Owned Corporations and State Holding Companies. 3. Presidential Decree “On Holding Companies, That Are Created Through Incorporating and Privatization�, May 11, 1994. #224/04. F. Laws Applying to Joint-Stock Corporations with State Share 1. /DZ RI 8NUDLQH ³2Q &RPSDQLHV´ ³ ´  6HSWHPEHU  1991 (last amended: March 7, 2002). #1576-XII. ³ ´  'HFHPEHU   ODVW 2. Presidential Decree “On Drastic Measures on Speeding the Privatization in Ukraine� amended: December 25, 2000) . #1374/2000. 3. Cabinet of Ministers. Resolution. 3 June, 1999. #951 (last amended: 29 November, 2001). “On Delegation of Rights to Manage State Corporate Shares to Cabinet of ([HFXWLYH %RGLHV´ ³ Ministers of Crimean Autonomous Republic, Ministries and Other Central and Local   ´  $QQH[ Lists of Corporations with State Shares, Rights of Management for Which Are Delegated to Certain Ministries. ³2Q 0DQDJHPHQW RI 6WDWH &RUSRUDWH 5LJKWV´ ³ 4. Cabinet of Ministers. Resolution. 15 June, 2000. #791 (last amended: 16 May, 2000). ´  Annex: Report of Authorized Representative. )RUP RI &RQWUDFW RI 'HOHJDWLRQ RI 5LJKWV WR 0DQDJH 6WDWH 6KDUHV´ ³ 5. State Property Fund of Ukraine. Order. May 24, 2000. #1065. “On Approval of Typical  ´  Annex: Typical Form of Contract of Delegation of Rights to Manage State Shares. 6. State Property Fund of Ukraine. Order. May 25, 2000. #1067. “On Approval of Typical Bodies´ General Agreement on Delegation of Rights to Manage State Shares to State Executive ³  7. State Property Fund of Ukraine. Order. May 29, 2000. #1109. “On Approval of Manage State Corporate Shares´ ³ Instruction on Order of Report Filling-Out by Representative of Body, Authorized to  ´  8. State Property Fund of Ukraine. Order. August 7, 2000. #1647. “On Approval of Typical Contract of Delegation of Management of State Corporate Rights to an Authorized Entity� ( 56 Annex 1 ´  9. State Property Fund of Ukraine. Ministry of Economy. Order. October 20, 2000. 5HFRPPHQGHG WR %H &ODVVLILHG $V RI 5HJLRQDO ,PSRUWDQFH´ ³ #227/2181. “On Approval of Criteria, Upon Which Open Joint Stock Companies Are    10. State Property Fund of Ukraine. Order. September 11, 2001. #1647. “On DQ 63)8 5HSUHVHQWDWLYH´ ³ Approval of Typical Contract of Delegation of Management of State Corporate Rights to  ´  'LYLGHQG 3ROLF\´  11. State Property Fund of Ukraine. Order. May 4, 2001. #781. “On Corporate - 57 Annex 2 ANNEX 2: MINISTERIAL SOE PORTFOLIOS SOE Governing Body 2007 2008 Number of SOEs, total in Ukraine 3,252 3,589 - kazenni enterprises 43 43 - state commercial enterprises 2,765 3,126 - joint-stock companies with state’s stake exceeding 50% 444 420 Cabinet of Ministers of Ukraine - joint-stock companies with state’s stake exceeding 50% 0 3 Line Ministries Ministry of Agrarian Policy, total 383 360 - state commercial enterprises 381 358 - joint-stock companies with state’s stake exceeding 50% 2 2 Ministry of Regional Development and Construction, total 40 41 - state commercial enterprises 39 40 - joint-stock companies with state’s stake exceeding 50% 1 1 Ministry of Housing and Communal Services 28 30 - state commercial enterprises 27 29 - joint-stock companies with state’s stake exceeding 50% 1 1 Ministry of Internal Affairs, total 39 47 - kazenni enterprises 1 1 - state commercial enterprises 38 46 Ministry of Coal Industry, total 412 413 - state commercial enterprises 247 258 - joint-stock companies with state’s stake exceeding 50% 165 155 Ministry of Economy 16 17 - state commercial enterprises 16 16 - joint-stock companies with state’s stake exceeding 50% 0 1 Ministry of Culture 38 62 - state commercial enterprises 38 62 Ministry of Defense 181 169 58 Annex 2 - kazenni enterprises 2 2 - state commercial enterprises 179 167 Ministry of Environmental Protection 0 33 - state commercial enterprises 0 33 Ministry of Health 28 29 - state commercial enterprises 28 28 - joint-stock companies with state’s stake exceeding 50% 0 1 Ministry of Natural Resources 46 52 - kazenni enterprises 3 3 - state commercial enterprises 41 47 - joint-stock companies with state’s stake exceeding 50% 2 2 Ministry of Fuel and Energy 108 111 - state commercial enterprises 106 106 - joint-stock companies with state’s stake exceeding 50% 2 5 Ministry of Social Policy and Labor 25 25 - kazenni enterprises 11 11 - state commercial enterprises 14 14 Ministry of Industrial Policy 304 291 - kazenni enterprises 18 18 - state commercial enterprises 277 266 - joint-stock companies with state’s stake exceeding 50% 9 7 Ministry of Communication and Transport 186 280 - state commercial enterprises 171 265 - joint-stock companies with state’s stake exceeding 50% 15 15 Ministry of Emergency Situations 29 33 - state commercial enterprises 29 33 Ministry of Youth Policy and Family 20 20 - state commercial enterprises 20 20 Ministry of Finance 11 11 - kazenni enterprises 7 7 - state commercial enterprises 4 4 Ministry of Justice 3 4 - state commercial enterprises 3 4 59 Annex 2 State Committees and Agencies State Committee for Supervision in Engineering 30 30 - state commercial enterprises 30 30 State Agency on Land 29 29 - state commercial enterprises 29 29 State Agency on Nuclear Regulation 3 3 - state commercial enterprises 3 3 State Committee on Water Resources 31 11 - state commercial enterprises 31 11 State Committee on Forestry 362 338 - state commercial enterprises 362 338 State Reserve Committee 33 27 - state commercial enterprises 33 27 State Statistics Committee 6 5 - state commercial enterprises 6 5 State Committee on Television and Radio 31 31 - state commercial enterprises 30 30 - joint-stock companies with state’s stake exceeding 50% 1 1 State Committee on Consumer Standards 39 40 - state commercial enterprises 39 40 State Committee on Financial Monitoring 1 1 - state commercial enterprises 1 1 State Property Fund n/a 219 - state commercial enterprises 0 10 - joint-stock companies with state’s stake exceeding 50% 232 209 State Space Agency 31 28 - kazenni enterprises 1 1 - state commercial enterprises 22 19 - joint-stock companies with state’s stake exceeding 50% 8 8 National Commission on Regulation of Communication 1 1 - state commercial enterprises 1 1 Pension Fund 1 2 - state commercial enterprises 1 2 60 Annex 2 Security Service of Ukraine 2 3 - state commercial enterprises 2 3 State Service of Automobile Roads 15 16 - state commercial enterprises 14 15 - joint-stock companies with state’s stake exceeding 50% 1 1 Anti-Monopoly Committee 1 1 - state commercial enterprises 1 1 State Securities’ and Stock Market Commission 10 10 - state commercial enterprises 10 9 - joint-stock companies with state’s stake exceeding 50% 0 1 State Border-Security Service 2 2 - state commercial enterprises 2 2 State Court Administration 6 5 - state commercial enterprises 6 5 State Committee on Fishery 38 34 - state commercial enterprises 38 34 National Agency on Energy Regulation 1 10 - state commercial enterprises 1 10 State Tax Administration 34 34 - state commercial enterprises 34 34 State Committee on Entrepreneurship 1 1 - state commercial enterprises 1 1 State Service for Special Communication 0 4 - state commercial enterprises 0 4 State Department for the Execution of Sentences 0 121 - state commercial enterprises 0 121 State Administrative Department 0 41 - state commercial enterprises 0 39 - joint-stock companies with state’s stake exceeding 50% 0 2 Local Governments 76 86 61 Annex 3 ANNEX 3: EXTRACT FROM THE OECD GUIDELINES CHAPTER 1: AN EFFECTIVE LEGAL AND REGULATORY FRAMEWORK The legal and regulatory framework for state-owned enterprises should ensure a level-playing field in markets where state- owned enterprises and private sector companies compete in order to avoid market distortions. The framework should build on, and be fully compatible with, the OECD Principles of Corporate Governance. Principle A: There should be a clear separation between the state’s ownership function and other state functions that may influence the conditions for SOEs enterprises, particularly with regard to market regulation. Principle B: Governments should strive to simplify and streamline the operational practices and the legal form under which SOEs operate. Their legal form should allow creditors to press their claims and to initiate insolvency procedures. Principle C: Any obligations and responsibilities that an SOE is required to undertake in terms of public services beyond the generally accepted norm should be clearly mandated by laws or regulations. Such obligations and responsibilities should also be disclosed to the general public and related costs should be covered in a transparent manner. Principle D: SOEs should not be exempt from the application of general laws and regulations. Stakeholders, including competitors, should have access to efficient redress and an even-handed ruling when they consider that their rights have been violated. Principle E: The legal and regulatory framework should allow sufficient flexibility for adjustments in the capital structure of SOEs when this is necessary for achieving company objectives. Principle F: SOEs should face competitive conditions regarding access to finance. Their relations with state- owned banks, state-owned financial institutions and other state-owned companies should be based on purely commercial grounds. CHAPTER 2: THE STATE ACTING AS AN OWNER The state should act as an informed and active owner and establish a clear and consistent ownership policy, ensuring that the governance of state-owned enterprises is carried out in a transparent and accountable manner, with the necessary degree of professionalism and effectiveness. Principle A: The government should develop and issue an ownership policy that defines the overall objectives of state ownership, the state’s role in the corporate governance of SOEs, and how it will implement its ownership policy. Principle B: The government should not be involved in the day-to-day management of SOEs and allow them full operational autonomy to achieve their defined objectives. Principle C: The state should let SOE boards exercise their responsibilities and respect their independence. Principle D: The exercise of ownership rights should be clearly identified within the state administration. This may be facilitated by setting up a coordinating entity or, more appropriately, by the centralization of the ownership function. Principle E: The coordinating or ownership entity should be held accountable to representative bodies such as the Parliament and have clearly defined relationships with relevant public bodies, including the state supreme audit institutions. Principle F: The state as an active owner should exercise its ownership rights according to the legal structure of each company. Its prime responsibilities include: 1. Being represented at the general shareholders meetings and voting the state shares; 2. Establishing well structured and transparent board nomination processes in fully or majority owned SOEs, and actively participating in the nomination of all SOEs’ boards; 3. Setting up reporting systems allowing regular monitoring and assessment of SOE performance; 4. When permitted by the legal system and the state’s level of ownership, maintaining continuous dialogue with external auditors and specific state control organs; 62 Annex 3 5. Ensuring that remuneration schemes for SOE board members foster the long term interest of the company and can attract and motivate qualified professionals. CHAPTER 5: TRANSPARENCY AND DISCLOSURE State-owned enterprises should observe high standards of transparency in accordance with the OECD Principles of Corporate Governance. Principle A: The coordinating or ownership entity should develop consistent and aggregate reporting on state-owned enterprises and publish annually an aggregate report on SOEs. Principle B: SOEs should develop efficient internal audit procedures and establish an internal audit function that is monitored by and reports directly to the board and to the audit committee or the equivalent company organ. Principle C: SOEs, especially large ones, should be subject to an annual independent external audit based on international standards. The existence of specific state control procedures does not substitute for an independent external audit. Principle D: SOEs should be subject to the same high quality accounting and auditing standards as listed companies. Large or listed SOEs should disclose financial and non financial information according to high quality internationally recognized standards. Principle E: SOEs should disclose material information on all matters described in the OECD Principles of Corporate Governance and in addition focus on areas of significant concern for the state as an owner and the general public. Examples of such information include: 1. A clear statement to the public of the company objectives and their fulfillment; 2. The ownership and voting structure of the company; 3. Any material risk factors and measures taken to manage such risks; 4. Any financial assistance, including guarantees, received from the state and commitments made on behalf of the SOE; 5. Any material transactions with related entities. 63 Annex 4 ANNEX 4: BENCHMARKING UKRAINE AGAINST THE OECD FRAMEWORK OECD Guidelines Ukrainian framework Observations and Issues 1. Ensuring an Effective Legal and Regulatory Framework for SOEs The legal and regulatory framework for SOEs should ensure a level-playing field in markets where SOEs and private sector companies compete in order to avoid market distortions. The framework should build on, and be fully compatible with, the OECD Principles of Corporate Governance. A. There should be a clear separation between A. The Ukrainian legal framework does not A. Lack of clear legal delineation of functions the state’s ownership function and other state support full administrative separation of results in confusion between industrial policy functions that may influence the conditions for responsibilities for ownership and industrial and the ownership functions of the state - the SOEs enterprises, particularly with regard to policy. The legal framework does not state functions simultaneously as the major market regulation. institutionalize a single state coordinating market player and arbitrator. agency for SOE management and oversight. B. Governments should strive to simplify and B. Operational practices and legal form under B. SOEs where the state’s share is greater than streamline the operational practices and the legal which SOEs operate are simplified, creditors 25% are protected from creditors’ claims. In form under which SOEs operate. Their legal allowed to press their claims and to initiate reality there are numerous direct and hidden form should allow creditors to press their claims insolvency procedures, except for kazenni subsidies from the state to support SOEs which and to initiate insolvency procedures. enterprises (which are protected by their special enables a large number of SOEs to continue legal status). operating. There exist some limitations on the activities that SOEs allowed to carry out according to their legal form. C. Any obligations and responsibilities that an C. Obligations and responsibilities that SOEs are C. This allows retaining a large number of SOE is required to undertake in terms of public required to undertake in terms of public services companies with no special responsibilities and services beyond the generally accepted norm are not clearly mandated by laws and regulation. obligations for social and public policy purpose 64 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues should be clearly mandated by laws or Such obligations and responsibilities are not in state ownership. General public has no access regulations. Such obligations and disclosed to the general public. to information of public services provided by responsibilities should also be disclosed to the SOEs and is not aware of their actual costs. general public and related costs should be covered in a transparent manner. D. SOEs should not be exempt from the D. SOEs are not exempt from the application of D. The weak judicial system creates difficulties application of general laws and regulations. general laws and regulations, including for creditors in enforcing their contracts and in Stakeholders, including competitors, should competition law. SOEs are not protected from obtaining overdue payments from SOEs. have access to efficient redress and an even- court challenges/lawsuits in cases where they handed ruling when they consider that their infringe the law. rights have been violated. E. The legal and regulatory framework should E. The legal and regulatory framework allows E. The state as an owner has no general policy allow sufficient flexibility for adjustments in the sufficient flexibility for adjustments in the and uses simple mechanisms to make necessary capital structure of SOEs when this is necessary capital structure of SOEs when this is necessary changes in SOEs’ capital structure as needed. for achieving company objectives. for achieving company objectives. F. SOEs should face competitive conditions F. The current legal framework gives SOEs a F. For some large SOEs, state-owned banks are regarding access to finance. Their relations with competitive advantage regarding access to the main creditors. In many instances, decisions state-owned banks, state-owned financial finance. SOEs’ relations with state-owned to extend credits to the SOEs are made not by institutions and other state-owned companies banks, financial institutions and companies the board of state-owned bank but by the should be based on purely commercial grounds. should be based on purely commercial grounds. government. SOEs prefer to conduct business with the government and state-owned banks than to raise capital in financial markets. 2. The state Acting as an Owner The state should act as an informed and active owner and establish a clear and consistent ownership policy, ensuring that the governance of SOEs is carried out in a transparent and accountable manner, with the necessary degree of professionalism and effectiveness. A. The state has neither clear definition of A. The government should develop and issue an A. The government has no clear and consistent objectives of state ownership, nor specific o nership polic that defines the o erall o nership polic that defines the o erall 65 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues ownership policy that defines the overall ownership policy that defines the overall targets in different sectors of the economy. objectives of state ownership, the state’s role in objectives of state ownership. the corporate governance of SOEs, and how it will implement its ownership policy. B. The government should not be involved in B. Legal framework restricts the government B. In reality, the lack of a clear and consistent the day-to-day management of SOEs and allow from day-to-day involvement into SOE strategy, not clearly delineated and overlapping them full operational autonomy to achieve their management and provides SOEs the autonomy functions result in excessive interference of the defined objectives. to achieve their objectives. government in day-to-day SOE activities. C. The state should let SOE boards exercise C. Normally, SOE boards enjoy independence C. Lack of a clearly defined government policy their responsibilities and respect their (from the state) in exercising their results sometimes in contradicting objectives independence. responsibilities. assigned to SOEs by different state agencies. D. The exercise of ownership rights is not D. Overlapping functions of different D. The exercise of ownership rights should be clearly identified. The ownership function is not coordinating entities and “owners� make system clearly identified within the state administration. centralized in a single strong coordinating entity. more complicated, ineffective and less This may be facilitated by setting up a transparent. coordinating entity or, more appropriately, by the centralization of the ownership function. E. The Cabinet of Ministers and SPF report E. Ownership entities report on SOEs E. The coordinating or ownership entity should annually to the Parliament on effectiveness of performance through aggregated performance be held accountable to representative bodies management of state assets. All coordinating indicators. In many aspects the aggregated such as the Parliament and have clearly defined entities and “owners� (ministries with SOE report of ownership entity could be misleading relationships with relevant public bodies, portfolios) report on SOE performance to the reporting hides the real picture in the sector. For including the state supreme audit institutions. Cabinet of Ministers, except for SPF (SPF, instance, targets on dividends could be met by which is responsible for joint-stock companies, few best performing companies in the sector and is accountable to the Parliament). consolidated report might overlook the lack of compliance by the remainder of the portfolio. In reality, neither government nor the public have a complete picture on performance in a given sector. Some ownership entities, other than SPF, do not make reports on SOEs performance publicly available nor do they report their own performance in exercising state ownership and in 66 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues achieving the state’s objectives. F. Legal framework allows the state to act as an F. There is evidence that the government either F. The state as an active owner should exercise active owner and to avoid political interference plays a passive role or interferes company’s its ownership rights according to the legal and passive state ownership through the business based on a political agenda: structure of each company. Its prime following mechanism: responsibilities include: 1. Procedures exist for state representation in 1. At shareholders’ meetings representatives of 1. Being represented at the general shareholders general shareholders meeting. different state bodies may have opposite views meetings and voting the state shares. and vote against each other. 2. Structured and competitive nomination 2. As a rule, selections are traditionally won by 2. Establishing well structured and transparent process for joint-stock companies’ board and preferred candidates nominated by the board nomination processes in fully or majority managers for unitary or kazenni companies. ownership entity itself. owned SOEs, and actively participating in the nomination of all SOEs’ boards. 3. Reporting systems envisages regular 3. Existing systems (reporting, monitoring and 3. Setting up reporting systems allowing regular monitoring and assessment of SOE performance evaluation) do not result in better understanding monitoring and assessment of SOE performance. by ownership entity. of the SOEs’ issues or in improved performance. The M&E system is vague and allows for the subjective evaluation of SOE and manager's performance. 4. The government can easily maintain dialogue 4. Ownership entities believe that they are in a 4. When permitted by the legal system and the with external auditors and special state control better position to know issues of their SOEs. state’s level of ownership, maintaining organs. There were cases when the Cabinet of Ministers continuous dialogue with external auditors and ignored valid recommendations of external specific state control organs. auditors. 5. Existing remuneration system permits to bring 5. Performance-based remuneration system for 5. Ensuring that remuneration schemes for SOE salaries of SOE managers closer to private sector SOE managers does not work properly. The board members foster the long term interest of practices. However, some restrictions for civil problem of remuneration for civil servants the company and can attract and motivate servants appointed to the board exist. representing the state in the board is to be qualified professionals. resolved. 3. Equitable Treatment of Shareholders The state and SOEs should recognize the 67 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues rights of all shareholders and in accordance with the OECD Principles of Corporate Governance ensure their equitable treatment and equal access to corporate information. A. The coordinating or ownership entity and A. Ukrainian legislation ensures that all A. The rights of shareholders are protected by SOEs should ensure that all shareholders are shareholders are treated equally. law. In some cases the state may abuse its role as treated equitably. a dominant shareholder, for example by pursuing objectives that are not in the interest of the company and thereby to the detriment of other shareholders. B. SOEs should observe a high degree of B. SOEs should observe a high degree of B. The law provides access to information by all transparency towards all shareholders. transparency toward all shareholders and the shareholders, however, the application of the law general public. is not consistent and often information is not made publicly available on the basis of “state secrets� or national security. C. SOEs should develop an active policy of C. The law envisages mechanism for C. In some cases the state holds consultations communication and consultation with all communication through establishing special with minority shareholders to improve decision shareholders. committees on communication. making process and the acceptance of key decisions. D. The participation of minority shareholders in D. The law and government regulations do not D. In some cases the state reassures minority shareholder meetings should be facilitated in specify any mechanism to facilitate minority shareholders that their interests are taken into order to allow them to take part in fundamental shareholders participation. consideration. corporate decisions such as board election. 4. Relations with Stakeholders The state ownership policy should fully recognize the SOEs’ responsibilities toward stakeholders and request that they report on their relations with stakeholders. 68 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues A. Governments, the coordinating or ownership A. The law requires recognition and respect A. Special mechanisms and procedures to entity and SOEs themselves should recognize stakeholders’ rights from all players. protect stakeholders’ rights are not established. and respect stakeholders’ rights established by In some cases conflicts occur between the state law or through mutual agreements, and refer to and other stakeholders; the government may the OECD Principles of Corporate Governance force SOEs to pursue goals which differ from in this regard. those that apply to the private sector without any compensation. B. Listed or large SOEs, as well as SOEs B. Large SOEs and SOEs pursuing important B. SOEs or coordinating entities do not provide pursuing important public policy objectives, public policy do not provide reports on reports on stakeholder relations. should report on stakeholder relations. stakeholder relations. C. The board of SOEs should be required to C. Internal codes of ethics for SOEs board or C. Evaluations of SOE boards and managers develop, implement and communicate management have not been developed and performance do not include an assessment (by compliance programs for internal codes of implemented. employees, civil servants, etc.) of their conduct ethics. These codes of ethics should be based on and ethical behavior. country norms, in conformity with international commitments and apply to the company and its subsidiaries. 5. Transparency and Disclosure State-owned enterprises should observe high standards of transparency in accordance with the OECD Principles of Corporate Governance. A. The coordinating or ownership entity should A. The MOE is mandated to prepare an annual A. Transparency and public disclosure of SOEs develop consistent and aggregate reporting on consolidated report on SOE performance. The performance is limited. The consolidated report state-owned enterprises and publish annually an report is primarily focused on financial is deemed by government as confidential aggregate report on SOEs. performance and the value of SOEs’ assets, and document and is unavailable to general public. includes limited, aggregated financial indicators In addition, important data (such as return on such as turnover, profit, cash flow, gross equity, equity/asset ratio) are not provided in the investment and dividends. Data (or indicators) report. The aggregated data contained in the such as return on equity, equity/asset ratio are report distorts the true performance of the SOE not provided. portfolio as few profitable enterprises mask the poor performance of other SOEs. 69 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues B. SOEs should develop efficient internal audit B. The corporate law requires that joint-stock B. The internal audit function in SOEs (other procedures and establish an internal audit companies, including those that are SOEs, than joint-stock companies) is subordinated function that is monitored by and reports directly establish internal audit and internal controls. directly to the enterprises’ management. to the board and to the audit committee or the Their reporting is important for the board’s Recently, the government introduced a new equivalent company organ. ability to evaluate actual company operations mechanism of internal controls at 42 largest and and performance. most important SOEs – auditors� from KRU monitor the financial transactions of these SOEs and to report to the central government and central KRU management. C. SOEs, especially large ones, should be C. The corporate law only requires an annual C. In rare circumstances do external audits subject to an annual independent external audit independent external audit of joint-stock comply with international standards and no based on international standards. The existence companies (including those that are SOEs). adequate procedures exist to ensure the selection of specific state control procedures does not of qualified external auditors. The quality of substitute for an independent external audit. audit reports is poor in many cases, and many SOEs do not comply with the audit requirement. It is unclear whether audit conclusions and auditor recommendations are acted upon by SOE management. D. SOEs should be subject to the same high D. The law with regard to the SOEs has no D. There is a very low level of disclosure and quality accounting and auditing standards as requirements of high quality auditing standards, transparency for SOEs, even when they have listed companies. Large or listed SOEs should disclosure and transparency as in case for significant impact on the state budget, carry high disclose financial and non-financial information publicly traded ones. risk borne by the state or have significant according to high quality internationally societal impact. recognized standards. E. SOEs should disclose material information on all matters described in the OECD Principles of Corporate Governance and in addition focus on areas of significant concern for the state as an owner and the general public. Examples of such information include: 1. A clear statement to the public of the 1. The government, coordinating entities and 70 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues company objectives and their fulfillment. SOEs have not completed this work yet. Anecdotal evidence: some SOEs have not even statutes yet;, in some of them statutes and other documentation does not comply with the law. 2. Transparent ownership and voting structure 2. In some cases ownership structure is unclear, of the company. i.e. which entity retains legal ownership of the state’s stake and who has responsibility for exercising the state’s ownership. In some cases representatives of different sate bodies vote in opposition to each other at shareholder meetings on strategic issues. 3. Disclosure of any material risk factors and 3. The existing system of identifying, assessing measures taken to manage such risks. and reporting on risks is weak and inadequate. 4. Disclosure of any financial assistance, 4. Disclosure of mutual obligations, financial including guarantees, received from the state and assistance, guarantees or risk sharing commitments made on behalf of the SOE. mechanisms does not include all details that might be important. 5. Disclosure of any material transactions with 5. The level of disclosure of information is very related entities. low and transactions between SOEs and related entities are undisclosed. 6. Responsibilities of the Boards of SOEs The boards of SOEs should have the necessary authority, competencies and Most of SOEs (except for those which are joint- objectivity to carry out their function of stock companies) do not have Boards of strategic guidance and monitoring of Directors. management. They should act with integrity and be held accountable for their action. A. In practice, SOE board members liability can A. The boards of SOEs should be assigned a A. SOE boards have the same responsibilities be reduced upon instruction by government. clear mandate and ultimate responsibility for the and liabilities as board of private enterprises Collective and individual liability of board ’ f Th b d h ld b ( ti l t d i l ) d i d 71 Annex 4 OECD Guidelines Ukrainian framework Observations and Issues company’s performance. The board should be (stipulated in company law), and are assigned a members is not clearly stated. There is no system fully accountable to the owners, act in the best clear mandate and responsibility for the in place to assess the impact of government interest of the company and treat all shareholders company’s performance. intervention on SOE performance. equitably. B. SOE boards should carry out their functions B. An SOE board is entitled to exercise guidance B. Despite the fact that their responsibility is to of monitoring of management and strategic and oversight of the CEO, subject to the define the overall objectives of an SOE, the guidance, subject to the objectives set by the objectives set by the government and ownership government and ownership entities tend to be government and the ownership entity. They entity. Boards have power to appoint and remove heavily involved in daily operations of an SOE. should have the power to appoint and remove CEOs and to sign contracts with them. In practice, boards have little authority in the CEO. establishing remuneration and in removing CEOs. C. The boards of SOEs should be composed so C. According to the law, boards should protect C. Diversity of board composition is not that they can exercise objective and independent shareholders’ rights, monitor senior management maintained and few of them are recruited from judgment. Good practice calls for the Chair to be and take strategic decisions. the private sector. Civil servants do not receive separate from the CEO. remuneration for their work as board members. It weakens the ability of the board to be efficient institute in SOE governance system. D. If employee representation on the board is D. Some SOE boards may have employee (or D. SOE boards may include employee mandated, mechanisms should be developed to trade union) representation. representatives as voting or non-voting guarantee that this representation is exercised members. effectively and contributes to the enhancement of the board skills, information and independence. E. When necessary, SOE boards may set up E. When necessary, SOE boards should set up specialized committees to support the full board E. specialized committees to support the full board in performing its functions, particularly in in performing its functions, particularly in respect to audit or communication. The board respect to audit, risk management and may also elect a corporate secretary responsible remuneration. for the communication with shareholders. F. SOE boards should carry out an annual F. SOE boards should carry out an annual evaluation to appraise their performance. F. evaluation to appraise their performance. 72 Annex 4 73 Annex 5 ANNEX 5: BIBLIOGRAPHY Aguilera, Ruth V. 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(YEAR), “Public Enterprises – Corporate Governance and the Role of Government�, Indian Institute of Management, Calcutta, mimeo CFA Institute (2007) China Corporate Governance Survey, Center for Financial Market Integrity, CFA, New York Elborgh-Woytek, Katrin; Mark Lewis (YEAR), Privatization in Ukraine: Challenges of Assessment and Coverage of Fund Conditionality, IMF Policy Discussion Paper no. XXX Glushko, Sergeii M. 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International Survey Evidence�, XXXX 74 Annex 5 Mattlin, Mikael (2007), “The Chinese Government’s New Approach to Ownership and Financial Control of Strategic State-Owned Enterprises�, Institute of Economies in Transition, Bank of Finland, Discussion Paper no. 10-2007 McGee, Robert W. (2008), “Corporate Governance in Asia: A Comparative Study�, Working Paper, College of Business Administration, Florida International University McGee, Robert W. (2008), “Corporate Governance in Asia: A Comparative Study of Indonesia, Malaysia, Thailand and Vietnam�, Working Paper, Chapman Graduate School of Business, Florida International University McGee, Robert W. (2008), “Corporate Governance in Asia: Eight Case Studies�, Working Paper, College of Business Administration, Florida International University McGee Robert W; Galina Preobragenskaya (2004), “Corporate Governance in Transition Economies: The Theory and Practice of Corporate Governance in Eastern Europe�, Working Paper, Andreas School of Business, Florida OECD (2005) Corporate Governance of State-Owned Enterprises: A Survey of OECD Countries, OECD, Paris OECD (2005) OECD Guidelines of Corporate Governance of State-Owned Enterprises, OECD, Paris OECD (2007) Ukraine Governance Assessment, OECD, Paris Shi, Chenxia (YEAR), “Recent Ownership Reform and Control of Central State-Owned Enterprises in China: Taking One Step at a Time�, XXXXX Sprenger, Carsten (2008), “The Role of State-Owned Enterprises in the Russian Economy�, International College of Economics and Finance, Moscow, mimeo Treasury Board of Canada (YEAR) Corporate Governance in Crown Corporations and Other Public Enterprises – Guidelines, Treasury Board Secretariat, Ottawa Van der Elst, Christoph (2005), “Management, Decision-making and Supervision of Belgian State Owned Enterprises: An Inefficient Patchwork?�, Tilburg and Ghent Universities, mimeo Van de Waller, Steven (2008), “Comparing the Performance of National Public Sectors: Comparative Problems� International Journal of Productivity and Performance Management, 57(4): 329-338 World Bank (2006) Held by the Visible Hand: The Challenge of SOE Corporate Governance for Emerging Markets, Washington, DC Yakovlev, Andrei (2008), “State-Business Relations and Improvement of Corporate Governance in Russia�, Institute of Economies in Transition, Bank of Finland, Discussion Paper no. 26-2008 75 Annex 5 Protocol on Corporate Governance in the Public Sector, Department of Public Enterprises, Pretoria 2002. “Program of Action of the Cabinet of Ministers of Ukraine: The Ukrainian Breakthrough: For People, Not For Politicians�, Cabinet of Ministers of Ukraine, Kiev 2007. On Approval of Methodological Guidelines on Application of Criteria for Determination of the Efficiency of Management of the State-Owned Enterprises, Order of the Ministry of Economy no. 314, Ministry of Economy of Ukraine, Kiev, 2007. Annual Report to Parliament: Crown Corporations and other Corporate Interests of Canada. Treasury Board Secretariat, Ottawa, 2004. Annual Report to Parliament: Crown Corporations and other Corporate Interests of Canada. Treasury Board Secretariat, Ottawa, 2006. Meeting the Expectations of Canadians – Review of the Governance Framework for Canada’s Crown Corporations. Treasury Board Secretariat, Ottawa, 2005. 2005 Status Report of the Auditor General of Canada, “Governance of Crown Corporations�. Auditor General of Canada, Ottawa, 2005. SOE-related Websites in Selected Countries France http://www.ape.minefi.gouv.fr/sections/qu_est_ce_que_l_ape/ Sweden http://www.sweden.gov.se/sb/d/8908;jsessionid=aD6C6s7D6XF- New Zealand www.ccmau.govt.nz Canada www.tbs-sct.gc.ca/ccpi-pise/index_e.asp Finland http://www.ktm.fi/index.phtml?l=en&s=8 Poland http://www.msp.gov.pl/index_eng.php?dzial=39&id=151 UK www.shareholderexecutive.gov.uk Germany www.bundesfinanzministerium.de 76 Annex 6 ANNEX 6: CORPORATE GOVERNANCE LANDSCAPE QUESTIONNAIRE 1. Ownership and Control Legal Reference o Question Y/N Response/Comments Source (I) The Structure of Ownership and Its Concentration Please provide data and statistics showing the total size of the SOE sector (kazenni, unitary and corporatized), and the total of Joint-Stock companies. Please further provide tables showing the breakdown: by type of SOE 1. (kazenni, unitary and corporatized) and by state share in JSC, (ii) industrial sector; (iii) for SOEs, by commercial vs. non-commercial (e.g., public good, public interest such as research enterprises, etc.) orientation In addition to the data required for point #1 above, please also provide data for 2. SOEs and JSC indicating revenue, profit, earnings by enterprise, by sector, by commercial vs. non-commercial 3. Using most recent available data please provide for the largest ten companies: a. Market capitalization as a percent of total market capitalization. b. Trading volume as a percent of total trading volume. c. Names of the first, second, third and fourth biggest shareholders, and specify their ownership positions. Please use ultimate shareholder information, if available. d. The size of the board (supervisory and management boards) for each company. For each of the last five years (and the most recent available month), please 4. provide: a. The number of public enterprises (SOEs, JSCs, etc.) that are candidates for new listings. Indicate how are they are expected to be listed on the exchange (obligatory listing by state, IPO or secondary offer, listing by shareholders and brokers). In general is ownership concentrated in the hands of a few families/investor 5. (If yes, how many?) groups/oligarchs? 77 Annex 6 If there are any available academic or market research reports on the 6. ownership structure of SOEs, Joint-Stock companies, public enterprises, please provide them in English. If not available in English, please summarize. Capital Market Background For each type of company form, including listed companies, please provide any 7. available data on: a. The total number of companies/economic entities. b. Num ber of em ployees c. Economic activity carried out by each company form (depending on available data, e.g. GDP, turnover, total sales/revenues, and exports). d. Provide any other meaningful statistic which, in your opinion, provides information regarding the role of the listed sector in the country’s economy. 8. For each of the last five years (and the most recent available month), please provide a table containing the following data. Please note sources for each. a. The level of the most widely used equity market index at the end-of- period. b. Number of listed companies at end-of-period (please provide separate details for different listing tiers or types of listed companies). c. Market capitalization at end of period, in local currency and in US$. d. Market capitalization to GDP ratio at the end of period (please indicate source of GDP estimates). e. Trading volume for each period. f. Market turnover ratio for each period (trading volume divided by market capitalization at end of year). Are any SOEs, Joint-Stock companies or public enterprises listed on foreign 9. exchanges? a. If so, please specify whether ordinary shares, GDRs or ADRs are listed on foreign exchanges. b. Please specify if these are Level I, II, III or SEC Rule 144A/Reg S Depositary Receipts. c. Please compare the trading volume for all dual listed companies on foreign markets vs. aggregate volume for these firms on the dominant local exchange. 10. Are multiple listings permitted on domestic exchanges? 11. How many companies offer bonds on the market? 78 Annex 6 Is there an informal market/economy in the country? If so, what is its trading 12. volume? 2 Please comment on the prevalence of pyramid structures and cross 13. shareholdings3. Include quantitative data for the market as a whole, if available. Can companies issue shares with varying voting rights (for example preferred 14. shares, founders shares, non-voting shares, multiple voting rights, removable voting rights)? Please explain the typical rights of each class of shares a. How frequently is each of these types of shares used in practice? 5. Describe the main requirements of the stock exchange for a company to become listed, including the initial requirements and continuing obligations. 2. Legal and regulatory framework Please provide copies in English of relevant laws and regulations or a reference to the websites from where they can be downloaded. Legal Reference or Question Y/N Response/Comments Source Provide a brief summary of the legal framework and institutions governing listed 1. companies. Please list all laws relevant to the governing of listed companies. Summarize recent significant legal developments affecting corporate 2. governance (especially company law, securities law and listing rules). What are the securities market regulator’s main registration requirements for 3. companies? a. How do these vary for non-listed public and listed companies? 4. Are there different listing segments on the stock exchange? a. If yes, please describe, focusing on corporate governance 79 Annex 6 6. Does a corporate governance code of good practice exist? a. If yes, who participated in the code’s preparation (e.g. securities market regulator, stock exchange, Center for Corporate Governance, etc.?). b. W ho is sued the c ode? c. Is it voluntary or mandatory? d. Must corporations disclose their degree of compliance (“comply or explain�)? e. On average/in percentage, how many companies comply with the code? f. How effective is it in practice? g. Is there any precedent of non-compliance? h. What are the legal and pecuniary consequences/sanctions in case of non-compliance? . i Are the sanctions adequate/meaningful according to the operational costs of the company? Which bodies in the public and private sectors (both domestic and foreign) have been active in promoting corporate governance reform? (For example, 7. institutes of directors, centers / institutes of corporate governance, associations of shareholders, or chambers of commerce). Please briefly describe their objectives, activities and achievements, and 8. provide their contact details. Please list in a table the different corporate forms which are allowed under the 9. law. a. Explain the main differences (e.g. partnerships, limited liability, joint-stock, public limited). b. W hi c h t yp e s c a n b e l i s t e d ? . c Which entities oversee other company forms? Please indicate which authority supervises the different company forms 10. (including listed companies). According to the company law and/or corporate governance framework, please 11. describe how powers are distributed in the company among board, general assembly, and senior management. Please describe any serious corporate governance scandal that has occurred in the past four years in the country, and provide written analyses in English. 80 Annex 6 a. Please list any key court ruling in the area of corporate governance that sets precedent on the interpretation of the law. b. How transparent is the legal reform process? Does it allow all affected parties to fully understand the new laws and regulations? 3. Historical influences on the current corporate governance system. Legal Reference o Question Y/N Response/Comments Source If there are any available academic or market research reports on privatization 1. trends, please provide them in English. If not available in English, please summarize. If there are any available academic or market research reports on industrial 2. policies please provide them in English. If not available in English, please summarize. If there are any available academic or market research reports on fiscal polices in general, and in particular tax treatment of inter corporate dividends and 3. capital gains, please provide them in English. If not available in English, please summarize. If present, please indicate legal and regulatory provisions governing ownership and control relationships of listed companies with banks and other financial 4. institutions. Please, also indicate academic or market research reports on the related governing policies. 81 Annex 7 ANNEX 7: ASSESSMENT QUESTIONNAIRE FOR FINANCIAL OVERSIGHT OF SOES ENSURING THE BASIS FOR AN EFFECTIVE CORPORATE GOVERNANCE FRAMEWORK Corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory, and enforcement authorities. A Corporate governance framework should be developed with a view to its impact on overall economic performance, market integrity and the incentives it creates for the market participants and the promotion of transparent efficient markets. Legal Reference o Question Y/N Response/Comments Source Do authorities have a strong commitment to improve the strength of corporate 1. governance in public sector companies/enterprises? Do authorities develop policy, laws and regulations etc., for the corporate 2. governance framework on the basis of effective and ongoing consultations with the public, corporations and shareholders? Please describe the consultation process for recent pieces of laws related to 3. corporate governance. B The legal and regulatory requirements that affect corporate governance practices in a jurisdiction should be consistent with the rule of law, transparent and enforceable. Legal Reference o Question Y/N Response/Comments Source 1. Are laws, regulations, and voluntary codes clearly written and well understood? Are corporate governance regulations predictable (i.e. not subject to important 2. temporary decrees and back-dated amendments)? Are laws and regulations consistent with one another, or do you know of cases 3. where a law or regulation contradicts or is inconsistent with another law or regulation? Do you think laws and regulations related to corporate governance are 4. enforceable? Are they difficult to enforce for some reason: complicated, vague, overreaching, etc? Does the market consider that the authorities responsible for overseeing the corporate governance framework (including the courts) act arbitrarily, or in a 5. manner that sometimes seems to indicate that they are not acting in accordance with the rule of law? 82 Annex 7 C The division of responsibilities among different authorities in a jurisdiction should be clearly articulated and ensure that the public interest is served. Legal Question Y/N Response/Comments Reference or Source Have Memorandums of Understanding been signed among the supervising If so, what are 1. they? ministries/agencies? 2. Which are the main tenets of the memorandums? 3. To what extent are the memorandums effective? 4. How often do the supervisory authorities share information about companies? Is there any precedent of examinations jointly coordinated by two or more supervisory 5. authorities? Please describe. 6. Does the division of supervisory responsibility lead to weak enforcement? If enforcement is weak, please comment on the reasons (e.g. lack of effective 7. powers or sanctions, shortage of qualified personnel or monitoring capacity). Please comment on the effectiveness of coordination of the supervisory 8. authorities in your jurisdiction. Are there key inconsistencies/overlaps in the laws and regulations which apply to 9. Joint-Stock companies, SOEs, etc.? Please describe them. Is the cost of compliance proportionate and appropriate? Does it often create 10. duplications? Please provide three examples (i.e., accounting standards, disclosure, etc.) 11. In your opinion, is the legal framework efficient? If any oversight over the corporate governance framework has been delegated to 12. self-regulatory organizations (e.g. stock exchanges), does the market consider that these organizations work transparently and in the public interest? Overall, what are the main supervisory concerns/complaints listed companies 13. tend to express? 83 Annex 7 D Supervisory, regulatory, and enforcement authorities should have the authority, integrity, and resources to fulfill their duties in a professional and objective manner. Moreover, their rulings should be timely, transparent, and fully explained Legal Reference o Question Y/N Response/Comments Source On Companies Registry/Companies House Is there a centralized institution(s) where companies (JSCs, SOEs, etc.) have to file 1. their fundamental documents (such as by-laws, initial board members, shareholder registry) as well as company financial information? a. Please describe the nature of the documentation lodged as well as who has access to it and how. b. What are the costs (if any) associated with consulting/copying/reviewing this information? c. What are its enforcement powers in cases of non-compliance with filing requirements? d. Please indicate on average number, and categories/types of sanctions and the total amount for the past two years. To whom does the Companies Registry report to? 2. Please comment on the institution’s overall effectiveness. 3. On Regulatory Oversight As an indicator of regulatory capacity, state how many employees work for the 4. securities regulator? 5. Have there been any changes in the number of specialized/skilled employees? What is the relative pay scale in relation to: comparable private sector employment 6. and to other regulatory bodies, like the Central Bank? How is the securities market regulator funded? (i.e. is it funded through budget 7. allocation from the government, or does it retain its fees and fines?) Are employees of securities market regulator regularly trained? If available, please 8. name three mandatory trainings employees have been required to attend. 84 Annex 7 Have employees been required to attend specific corporate governance trainings as 9. well? What role does the securities market regulator have in the recommendation, drafting 10. and proposing of rules, regulations and statutes? a. Does it have the power to issue prudential rules and other regulations? b. Are those rules posted for public consultation before they go into effect? c. What are the means market participants have to have their voice heard in the consultation process? d. Have they been effective in producing regulatory changes? Please name two instances. How many employees in the securities market regulator act as “inspectors�? 11. Does the securities market regulator have full access to a registrant’s books and 12. records? Can the securities market regulator subpoena documents from registrants and their 13. employees, even if located off-site? Can the securities market regulator subpoena documents from issuers, non- 14. registrants or third parties, such as phone records, email records or bank records? Can the securities market regulator question registrants and their employees 15. regarding their activities? Describe the internal procedures for an administrative proceeding in the securities 16. market regulator: a. Who adjudicates the proceeding? b. Is a finding appealed administratively or through the court system? c. Describe the appeal process and whether it is used frequently/almost always and whether decisions are reversed. d. Is the administrative sanction enforced/collected (e.g. does the fine have to be paid) before the appeal process? Describe the type and range of sanctions that can be imposed: 17. 85 Annex 7 a. Directly by the securities market regulator (such as suspensions of licenses, fines, injunctions, and receiverships). b. By other entities on the advice of the securities market regulator. c. By other entities, on their own decision, without the advice of the regulator, for violations of the securities market regulator’s laws and regulations. Does the securities market regulator publish enforcement statistics in its annual (Please provide a copy of the annual report.) 18. report? Please provide statistics on investigations and proceedings, answering the following 19. . questions: a. Average length of time from inception of violation to investigation, to initiation of proceeding and end of proceedings. b. Number of investigations by type over the last three years. c. Number of administrative proceedings, civil cases and criminal prosecutions by type over the last three years. d. Please provide statistics over the last three years regarding the imposition of sanctions by year, type and severity. e. Please provide statistics over the last three years the percentage of sanctions paid partially or in full, length of time for payment, number of violations of suspensions and injunctions. f. Are rulings publicly available (i.e. on the website) and are they explained? What government entity brings criminal cases for violations of the securities and 20. corporate laws? a. Ov er the last three years, please provide how many cases were brought, the nature of the violation and the penalty imposed. Do commercial, corporate or securities arbitration exist? (If yes, how does it work?) 21. How commonly is it used as a means of action against board members or 22. controlling shareholders? Are arbitration decisions binding and final? 23. 86 Annex 7 DISCLOSURE AND TRANSPARENCY The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company. A. Disclosure should include, but not be limited to, material information on: Question Y/N Response/Comments Legal Reference o Source A1. The financial and operating results of the company. Please prepare a schedule of the requirements for periodic disclosure of 1. financial and non-financial information by issuers. a. Specify the origins of these provisions in each case (statutory, regulatory, company articles of association). b. Explain to whom these disclosures should be made and with what frequency (annually, semi-annually, quarterly). 2. Are companies required to publish an annual report? 3. Does the annual report include: a. Balance s heet. b. Profit and loss statement. c . Cas h flow s tatement. d. Statement of changes in ownership equity. e. Notes to the financial statements. f. A u d i t r e p o r t . 4. Are companies required to submit a board report with the annual report (sometimes called a chairman’s review, directors’ report, management discussion and analysis, etc.)? Please provide a detailed description of the required contents (if any) of the board report. Does the board report specifically include: a. Management assessment of the factors that affected the company’s financial condition, b. Known trends that may affect company’s financial condition in the future. 87 Annex 7 5. Are companies required to file consolidated financial statements? 88 Annex 7 A. Disclosure should include, but not be limited to, material information on: Question Y/N Response/Comments Legal Reference o Source How does the securities market regulator monitor the compliance of listed 6. (Please comment and provide examples.) companies with reporting requirements (e.g., on-site inspection/sampling)? 7. a. What are the sanctions for non-compliance? E.g. warning, fines, suspension of trading, public reprimand, restatements, civil penalties, criminal penalties, etc. 8. b. How frequently are they applied in practice? Please provide statistics over the past five years by type of sanction. 9. Are there effective mechanisms for those harmed by inadequate disclosure? How do investors perceive the general adherence of companies to the rules 10. regarding reporting of financial and non-financial information? Please (Please rate as “Poor,° “Fair° or “Excellent.°) provide data on compliance, if available. A2. Company objectives. Does the legal and regulatory framework require companies to disclose in 11. detail their commercial and non-commercial objectives? A3. Major share ownership and voting rights. Please describe the requirements for ownerships information to be disclosed by 12. owners/shareholders. a. Who has the responsibility to disclose and to whom? b. How is the information disclosed and disseminated? c. What are the ownership thresholds of disclosure? d. Do the disclosure requirements cover direct and indirect shareholding structures, including situations where shareholders are acting in concert? 13. Can regulatory and enforcement agencies obtain information about ultimate ownership? 89 Annex 7 A. Disclosure should include, but not be limited to, material information on: Question Y/N Response/Comments Legal Reference o Source 14. Please describe the requirements for the disclosure of ownership and control by companies in their periodic disclosures: a. Are companies required to disclose their significant shareholders? What are the thresholds of disclosure? b. Do disclosure requirements cover direct and indirect shareholding structures, including situations where shareholders are acting in concert? c. Voting rights attached to different classes of shares d. Caps on voting rights e. Cross share holdings f. Inter-group shareholdings (if part of a group) g. W ho c o n t r o l s t h e c o m p a n y ? h. When and how do companies disclose this information? 15. Do the rules allow shareholders to understand the mechanisms of the company? Please describe any information or impression on company compliance with these 16. regulations. A4. Remuneration policy for members of the board and key executives, and information about board members, including their qualifications, the selection process, other company directorships and whether they are regarded as independent by the board. Do companies disclose (in annual reports or shareholder’s meetings) about board 17. members: 18. a. their qualifications and other memberships? 19. b. the selection process? 20. c. their independence? 21. d. o ther m at eria l in form ation? Does the corporate governance framework require or recommend that board 22. members and key executives periodically disclose their ownership stakes in the company? 90 Annex 7 Are board members and key executives required to disclose transactions in their 23. company’s securities on a timely basis (including transactions by their close family members or associates)? 24. Is disclosure of remuneration of board members and key executives required in the annual report? Please explain which elements of remuneration must be disclosed (salary, benefits, bonuses, share awards, stock options, loans 5 and SARs ) and whether these are disclosed for each individual, or in the aggregate. A. Disclosure should include, but not be limited to, material information on: 25. Are companies required to disclose their remuneration policies? Are companies required to disclose the link between remuneration and company 26. performance? Are companies required to disclose the different forms of requirements such as 27. pension benefits and deferred remuneration? A5. Related party transactions. Are there any requirements for companies to disclose potential related party 28. transactions before they take place? Is there a requirement for companies to disclose information on related party 29. transactions on a periodic basis? Are companies required to disclose the identity of controlling shareholder(s) 30. (even if there were no transactions between the related parties)? 31. When related party transactions are disclosed, are listed companies required to describe: 6 a. Type of transactions with related parties. b. Details of the transaction(s) including whether it was at market price. 32. What are the administrative penalties the company may incur if it does not observe related party transaction rules? Is there a requirement to disclose borrowing from a related bank (a bank with a 33. major shareholder in common with the company) or other related financial institution in the annual report or through another channel? In your professional opinion, do related party transactions take place under 34. transparent conditions, and are they sufficiently disclosed in practice? Please explain and provide examples. 5 Stock Appreciation Rights. 91 Annex 7 6 Under IAS items of a similar nature may be disclosed in aggregate except when separate disclosure is necessary for an understanding of the effects of related party transactions on the financial statements of the reporting enterprise. 7 The following questions are based on IAS 24. A. Disclosure should include, but not be limited to, material information on: Question Y/N Response/Comments Legal Reference o Source 35. Are the following entities treated as related parties? 7Please indicate the legal source for each requirement (e.g. securities law, accounting regulations, listing rules, etc.) a. Controlling shareholder / holding company / controlling entity b. Company subsidiaries c. Fellow subsidiaries (i.e. an entity under common control with the reporting entity). d. Associates (i.e. an enterprise, other than a subsidiary or a joint venture, over which the investor has significant influence. Significant influence means the power to participate in financial and operating policy decisions. Such influence is presumed to exist if the investor owns more than 20 percent of voting rights). e. Individuals who, through ownership, have significant influence over a company and close members of their families. f. Key management personnel (including executive and non-executive board members) and their close families. g. Enterprises in which a substantial interest is owned by any of the individuals included above. h. Parties with joint control over the reporting enterprise, co-ventures with the reporting enterprise in joint venture, and close family members of those parties if they are individuals. i. Linked Pension plans. A6. Foreseeable risk factors. 36. Is there a requirement for companies to disclose in their annual reports: a. their policies and procedures on risk management 92 Annex 7 b. their material foreseeable risk factors, including risks that are specific to the industry or geographical areas in which the company operates; dependence on commodities; financial market risk including interest rate or currency risk; risk related to derivatives and off-balance sheet transactions; and risks related to environmental liabilities 93 Annex 7 A. Disclosure should include, but not be limited to, material information on: Question Y/N Response/Comments Legal Reference o Source A7. Issues regarding employees and other stakeholders. 37. Is there a requirement or recommendation to disclose material issues regarding employees (e.g. human resources policies and information on other stakeholders (e.g. creditors, suppliers or local communities)? a. To whom and through what channels should disclosure be made? A8. Governance structures and policies, in particular, the content of any corporate governance code or policy and the process by which it is implemented. 38. Are there requirements for disclosure relating to company governance structures and policies? (In particular, the division of authority between shareholders, management and board members.) Do companies regularly disclose their compliance with a code of corporate 39. governance? a. How frequently is this disclosure made? b. Do they have to explain areas of non-compliance? c. Does any authority confirm or audit this disclosure? B. Information should be prepared and disclosed in accordance with high quality standards of accounting and financial and non-financial disclosure. Legal Reference o Question Y/N Response/Comments Source 1. What accounting standards are required for listed companies? a. How do these compare to International Financial Reporting Standards (IFRS)? Are they a recent translation, an old translation, harmonized in some other way, or distinct? b. Are there any reports or other research that compare national standards to local standards, if so please provide. c. Please comment on compliance of listed companies with the Accounting Standards. 94 Annex 7 2. How are the domestic accounting standards determined? How often are they reviewed? When the standards were last redrafted? What determines non-financial disclosure by companies: accounting standards, 3. company law, a corporate governance code, something else? 4. What are the mechanisms used to effectively punish companies which disclose accounting information in inadequate or misleading fashion? C. An annual audit should be conducted by an independent, competent and qualified, auditor in order to provide an external and objective assurance t the board and shareholders that the financial statements fairly represent the financial position and performance of the company in all material respects Legal Reference o Question Y/N Response/Comments Source Is there a requirement that listed companies have their annual financial 1. statements externally audited? 2. What are audit standards used? a. How do local Auditing Standards differ from the International Audit Standards? Is the independence of the external auditor defined? If so, specify how and by 3. which law or institution. How do independence requirements differ with the IFAC independence 4. requirements of the code of ethics? (If yes, does this apply to the specific partner in charge or to 5. Are listed firms required to rotate auditors every certain number of years? the firm?) Please describe any restrictions on non-audit services that may be carried out 6. by auditors for their audit clients Is there a cooling-off period before a member of the audit engagement team 7. (If yes, how long is this period?) may accept employment with the client? 8. Is there a second tier of reputable and quality auditing firms? Are company’s boards (or Audit Committees or equivalent body) by law or regulation 9. required or recommended to report to the shareholders on: a. Actions taken and bases upon which the oversight body deems the auditor independent and qualified? b. Actions taken and bases upon which the board deems the auditor to have acted with due professional care? c. The value of non-audit work completed by the auditor for the company? 95 Annex 7 D. External auditors should be accountable to the shareholders and owe a duty to the company to exercise due professional care in the conduct of the audit. Legal Reference o Question Y/N Response/Comments Source Does the corporate governance framework clearly provide that external auditors 1. are accountable to the company’s shareholders in respect to the performance of their audit functions? Who has the final authority to approve the appointment and dismissal of the 2. external auditor (e.g. management, board, audit committee, General Meeting of Shareholders)? a. In case the appointment is made by the General Meeting of Shareholders, is it your perception that shareholders always approve board recommendations? To which company organ do auditors report (i.e. management, board, audit committee of the board)? Is there a requirement for external auditors to inform the board, shareholders 3. and/or the supervisory authorities about any involvement of board members or senior management in illegal activities, fraud or insider abuse? 4. Are auditors required to purchase an insurance policy against lawsuits? (If so, please provide details and illustrate how common it is.) Are the following liable for false or misleading statements? Please differentiate 5. between civil and criminal liability, and between company and personal li bilit a. Board members/directors. b. External auditors. c. Senior management (CEO, CFO, etc.). 6. Can shareholders and/or stakeholders sue external auditors? a. Are there examples of auditors being sued successfully or unsuccessfully under these rules? b. Are there preset liabilities or maximum penalties in case of negligence or fraud? 7. Do shareholders have the right to request an independent audit at company expense if they doubt the accuracy of the auditor’s findings? 96 Annex 7 E. Channels for disseminating information should provide for equal, timely and cost-efficient access to relevant information by users. Question Legal Reference o Y/N Response/Comments Source Does the corporate governance framework prevent selective disclosures by 1. companies, board members and other insiders of material non-public information except for clearly defined exceptions? Is there a requirement in securities regulations or listing rules for companies to 2. continuously disclose all material information? a. How is materiality defined? b. How much time do issuers have to make disclosure of material information and to whom? c. Is the announcement pre-vetted by the stock exchange? d. Is trading sus pended? e. How do investors perceive the general adherence of companies to the disclosure requirements? f. Are there effective mechanisms for those harmed by inadequate disclosure? 3. Please describe how can shareholders obtain the following types of information. Please comment on cost, ease of access, and availability of information. a. Annual Report. b. Material evident disclosure. c. Articles of association. d. Minutes of board meetings. e Board attendance. . f. General Meeting of Shareholder minutes. 4. In practice, do companies publish the full financial information on their websites? 5. Does the Stock Exchange maintain a website with information disclosed by companies? 6. Does the Security and Exchange Commission maintain website information disclosed by companies? 97 Annex 7 wb259294 C:\Users\wb259294\AppData\Local\Temp\notes280E9C\Draft Report_June 28 2010.docx 6/29/2010 4:20:00 PM 98 Annex 7 99