7 April 2019

The defense corruption scandal involving Ukraine’s state defense conglomerate UkrOboronProm (UOP)  in the midst of Ukraine’s presidential campaign has become the part of the campaign debate ahead of the April 21 vote.

Investigative journalists recently reported that a corruption scheme operating since 2015, the year President Petro Poroshenko appointed his business partner Oleh Hladkovsky deputy secretary of the National Security and Defense Council, has cost Ukraine at least $9.2 million. Allegedly, Hladkovsky’s son Ihor organized a group that resold unaccounted for and undocumented equipment stored by Ukroboronprom to its own companies or sold to Ukroboronprom smuggled, often malfunctioning, Russian equipment.

The corruption that has been exposed is outrageous for any country, but it is not particularly surprising. An appalling lack of clear governance and a failure of oversight has made such schemes a part of Ukrainian political life, and getting rid of them is as vital to securing the country as soldiers and up-to-date weapons.

Establishing good governance within UOP will require tackling two main challenges. First, the state-owned company is seen by many in power as a money-making machine; second, there is no independent supervision of its activities that could prevent them from doing so. It needs serious restructuring.

UOP is a conglomerate of state-owned enterprises (SOEs), which means that its ultimate purpose should be to maximize value for society through an efficient allocation of resources—not to serve the interests of a limited number of individuals. The OECD Guidelines on Corporate Governance of State-Owned Enterprises are clear: they say that governments should allow SOEs full operational autonomy to achieve their defined objectives, and refrain from intervening in SOE management. They should let SOE boards exercise their responsibilities and respect their independence.

This is far from being implemented in the UOP case, where there has been constant interference in the institution’s functions by the government and the president. Worse, such interference is actually legally required by law: the president and government have the authority to appoint members of the UOP supervisory board, opening it up to political cronies and friends.

There is another problem linked to the UOP’s supervisory board members: they are expected to work for free. The OECD standard requires a clear remuneration policy for SOE boards, in order to foster the enterprises’ medium- and long-term interests and attract qualified professionals. The fact that UOP supervisory board members receive no remuneration means that it cannot interest knowledgeable and independent professionals to join the board—and those who do join may use their position to enrich themselves.

The provisions that allow presidential and government interference in UOP’s operations make it easier for powerful individuals to derive income through kickbacks, inflated contract prices, and the use of unscrupulous agents and middlemen. It is likely that the corruption schemes uncovered by investigative journalists recently are only the tip of the iceberg.

What can be done about this problem? Everybody knows that UOP will have to be restructured, but there is little agreement on how to do it.

Organizationally, UOP is no exception to the trend among state-owned enterprises in many other post-communist countries, which all had to deal with huge conglomerates of companies in different industries. When members of the Defense Corruption Monitoring Committee (NAKO) talk to policymakers from those countries, one of the points that comes up consistently is privatization. For sure, the current organization can be improved significantly and some—if not all—divisions of the company can be privatized. But we should not forget that privatization in post-communist countries has always been among the most popular and lucrative forms of illicit enrichment among a society’s elites, and has been used by those in power to build and sustain patronage networks that consolidate their power and control. Not everybody asking for the restructuring or even the abolition of the UOP has honest intentions and the real interests of Ukraine at heart, and the process needs to be approached with significant caution.

In order to safely move forward with restructuring UOP, the risks can be mitigated through an independent audit that will show the institution’s deficiencies and flaws, find and assess opportunities for the illicit depletion of assets, and suggest the most economically and socially sustainable reforms for the company. An audit was approved in 2017 but has not been launched yet, in part because the government says it cannot find the funds to conduct a full international audit.

In reaction to the corruption scandal, President Petro Poroshenko adopted a presidential decree stating that the international audit of UOP should start within a month, by Aril 15. It’s time for this to happen—and for the government to find the money to pay for the audit. That would be a small but vital first step toward greater security for the Ukrainian people.

NAKO Member Drago Kos for Kyiv Post.