Will Ukroboronprom be transformed from a corrupt defence industry monster into a modern and efficient structure? Will reforming the Concern cement the Soviet principles of governance? Will it happen at all? The document that was confirmed by the Cabinet of Minister as the Strategy for Defence Industry Development doesn’t answer this question.
On April 14, the Cabinet of Ministers approved the Strategy for Defence Industry Development. However, so far it lacks an Annex defining further reform of the state conglomerate Ukroboronprom. The Strategy defines the priorities of the state’s defence industry policy, and the goals and expected results of defence industry reform. Within the last year, the document was drafted in three different versions. In September, the Ministry of Economy published its version of the Strategy, which was developed transparently engaging a wide range of stakeholders. However, Vice Prime Minister Oleh Urusky asked that it be removed from public display. The next two versions were developed solely and exclusively by the Ministry of Strategic Industries (Minstrategprom), without the involvement of Ukraine’s international partners and civil society representatives.
Clash of Philosophies Continues
Having analyzed the last version of the Strategy, NAKO (the Independent Defence Anti-Corruption Commission) has revealed a number of inconsistencies between the Euro-Atlantic principles and “international practices” declared by the Minstrategprom, and Soviet approaches enshrined in the strategic documents.
The key progressive moment is that the Strategy stipulates transforming defence state-owned enterprises into business entities and forming science and production associations according to industry principles. The document also confirms that the state defence conglomerate Ukroboronprom will cease to exist, as it will be transformed together with the member companies in its vertically-integrated structure.
However, simultaneously with these plans to modernize Ukraine’s defence industry, the Strategy includes excessive functions for the Minstrategprom that were common to Soviet ministries, which were policymakers and, at the same time, controlled enterprises as owners.
At yesterday’s government session, Vice Prime Minister for European and Euro-Atlantic integration Olha Stefanishyna, in an emergency effort, managed to bring the draft Strategy closer to Euro-Atlantic standards.
Stefanishyna incorporated an amendment into the main body of the Strategy to minimize the Minstrategprom’s conflict of interest. She suggested dividing the functions of owner and policy-maker in the list of key directions for defence industry policy. Stefanishyna’s suggested amendments considerably improved the Strategy from the point of view of meeting the Organization for Economic Cooperation and Development (OECD) corporate governance principles, which are the best world practices for managing state-owned enterprises.
One of the key OECD principles (III, A) states that there should be a clear division between the function of state ownership and other state functions that can influence the activity of state-owned enterprises. Namely, it refers to regulating the market. The Minstrategprom already forms and implements the state’s defence industry policy. If it also had owner organization functions, it would create a clear conflict of interest and corruption risks.
Also due to Stefanishyna’s amendment, the Strategy anchors corporate governance according to OECD principles as one of the directions of the state’s defence industry policy. This is a crucial advantage, as it establishes a baseline for the government officials who will carry out the reform, and it will minimize their opportunity to decide with sole discretion what is better for Ukraine’s defence industry: international standards or Soviet ones.
The issues raised by Stefanishyna’s amendments for OECD corporate governance standards and removing Minstrategprom’s conflict of interest not only represent the expectations of our partners from the EU and NATO countries, but are also a condition of U.S. security assistance, which amounts to $250 million this year.
How to combine something that cannot be combined
“It is absolutely unacceptable to combine regulatory functions, policy-making functions, and economic functions in one structure,” Oleh Urusky, in his interview to LB.ua, July 20, 2020.
Indeed, excessive concentration of powers within one governmental body is unacceptable. But in practice, it is exactly what the Ministry of Strategic Industries’ Charter and the Strategy for the Defence Industry anchor at the legislative level.
The main idea of the Strategy is “a combination of centralised public administration with modern market mechanisms.” That is pretty hard to imagine, as in the real world there are either market mechanisms or a centralised government. In the first version of the document, the Minstrategprom emphasized that excessive centralisation was one of the reasons why Ukraine’s defence industry is in such poor condition. In the new edition, the authors of the Strategy no longer think that excessive centralisation has a destructive effect.
The Ministry explicitly states the need to subordinate all state defence enterprises during their transformation, which contradicts OECD guidelines. Draft Law №3822 on the reform of state-owned enterprises contains the same risk, providing for two management entities, with the Ministry of Strategic Industries being one of them. In order to mitigate the risks of a conflict of interest, NAKO has already recommended the Parliamentary Committee designate the Cabinet of Ministers as the sole governing body. Unlike the Minstrategprom, the Cabinet of Ministers does not develop defence industry policy.
The most interesting part is hidden in the Strategy’s ‘secret’ Annex. The draft Strategy developed by the Minstrategprom was not publicized. NAKO received both versions of the document via inquiries for access to public information. Civil society is especially concerned about this ‘secret’ Annex to the Strategy developed by the Minstrategprom, which it tried to hide from the public.
The Annex reveals the full discrepancy between the Euro-Atlantic principles declared by the Minstrategprom in the main body of the Strategy and the Soviet-style approaches to governance.
Luckily, the Government did not approve this Annex with the Strategy and sent it for follow-up revision. It is currently unclear if the Annex will be considered and, if so, when and according to which procedures. NAKO insists that if the Annex to the Strategy is adopted in the way it is now, Ukraine risks reversing its ambitious Euro-Atlantic reforms back to the old Soviet governance practices.
“…our [Minstategprom’s and Ukroboronprom’s] visions of the future transformation of Ukroboronprom are not very different. There are some differences as to what those holding companies will be like,” Oleh Urusky, interview to LB.ua, July 20, 2020.
The Strategy states that one of the main shortcomings of the existing management system in the defence industry is the direct and unhindered interference of Ukroboronprom in the economic activities of its member companies. According to the Ministry, this causes a high level of corruption at Ukroboronprom. At the same time, the Ministry does not see a threat in its own non-transparent and accountable activities, endless conflicts of interest, and lack of corporate governance at state-owned defence enterprises.
In order to overcome this corruption and solve other problems, the Minstrategprom is declaring a course of corporatization that was previously proposed by Ukroboronprom, but on its own terms and according to its own scenario. The Ministry wants to enshrine in the Strategy its own key role in corporatization. At the same time, the Strategy ignores Draft Law №3822, which was adopted in the first reading and should be the foundation for Ukroboronprom’s transformation.
In December 2020, Oleh Urusky suggested fast-track corporatization for several aviation companies, without waiting for Draft Law №3822 to be adopted. He explained that the situation at those enterprises was extremely critical, which allegedly required swift action to prevent further escalation of the conflict. At the same time, Chairman of the Parliamentary Committee on National Security, Defence, and Intelligence Oleksandr Zavitnevych opposed this idea because of the critical risks that may arise for these state-owned enterprises in case of extraordinary corporatization.
Four months have passed, and now, according to the Annex to the Strategy, the Ministry suggests corporatizing all defence enterprises, bypassing Draft Law №3822.
Manual control? Manual control.
“I am a supporter of corporate governance. The fewer functions I have in a company that is subordinate to the Ministry, the calmer I am,” Oleh Urusky, in his interview to LB.ua, July 20, 2020.
Without any doubt, NAKO agrees with the Vice Prime Minister. However, Urusky’s words seem to differ from the Ministry’s actions: the Minstrategprom has repeatedly tried to establish manual control over defence enterprises. In Autumn 2020, the Ministry tried to subordinate several successful aviation companies. Later, Ukroboronprom itself made a public statement about the Ministry’s attempts to interfere in the conglomerate’s business activity. Eventually, the situation reached the level of the Parliamentary Committee and the Vice Prime Minister had to justify his words by assuring there was no manual control.
To avoid the risk of manual control, Ukraine’s defence industry needs an effective system of “checks and balances”, which is what corporate governance ensures in the management of state-owned enterprises. The Strategy has repeatedly addressed the need to implement corporate governance according to OECD Standards and more abstract “international best practices.” However, the document lacks specific guidelines on how to implement such governance and the clear key performance indicators to assess progress.
For example, in the earlier version developed by the Ministry of Economy, the percentage of state-owned enterprises that have implemented OECD Standards was one of the effectiveness indicators. In the Minstrategprom versions, everything is rather vague: efficiency will be determined by “the formation of the organisationally and functionally balanced structure of the defence industry.”
According to the Annex, the Ministry also plans to approve the charter of vertically-integrated structures, i.e. future holdings, corporations, and consortia that will be formed as a result of transforming Ukroboronprom’s enterprises. This questions the quality of corporate governance at the transformed enterprises.
If the Annex is approved, the Ministry, as the body that initiates creating the state holding, will not only approve but also develop its charter. That is, future supervisory boards and other governing bodies, their competencies, and formation procedures will depend entirely on the Ministry. Under such conditions, it will be impossible for supervisory boards to be independent from Minstrategprom.
Ukrainian “Best International Practices”
G7 ambassadors have repeatedly stressed the importance of Ukroboronprom’s quality reform in accordance with OECD Standards. “Failure to maintain this reform path would be a missed opportunity for Ukraine to align its defence sector with international standards,” they wrote. In its 2020 report, the European Commission emphasized that Ukroboronprom’s corporate reform was stagnating and that EU macro-financial assistance and IMF programs required progress in several areas of corporate governance.
The United States, providing us with security assistance in 2020, stressed the important role of anti-corruption reforms in the defence industry for Ukraine’s Euro-Atlantic integration and compliance with OECD standards in the management of state-owned defence enterprises. The main body of the Strategy includes recommendations from Ukraine’s international partners, but the Annex basically ignores them.
This means that instead of the OECD guidelines, i.e. the world’s best practices for managing state-owned enterprises, the Annex can “cement” Soviet practices of centralised management and direct subordination of enterprises to the governing body, to which the Ministry of Strategic Industries appoints itself. Reform of the defence industry, if it is built on violating basic OECD principles, will definitely not correspond to the best international practices and will push Ukraine’s Euro-Atlantic integration back.
Urgent Need for Public Hearings
Under such non-transparent conditions, public discussion of this document is acute. After Cabinet of Ministers approval, the Strategy will be submitted to the National Security and Defence Council. Before the Council considers and potentially approves this document, we call on the responsible state bodies to hold public hearings on the Strategy and its Annex.
In this call, NAKO is supported by StateWatch, Bihus.Info (NGO Tom 14), and the Defence Procurement Reform Project, with the support of the UK Ministry of Defence and the NaUKMA Anti-Corruption Research and Education Center.
The Strategy for Defence Industry Development and its ‘secret’ Annex that discloses specific government plans should not be adopted in a non-transparent way. Building a competitive defence industry and well-equipped Ukrainian army cannot be a behind-the-scenes issue, as it influences the interests of all citizens of Ukraine. Everyone should understand the path the government chooses for its defence industry.
Defence industry reform should bring us closer to NATO, not push us back to Soviet approaches.