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23 September, 2020
A turbulent summer for Ukraine’s defense industry reform: step forward, step backward?

The summer of 2020 has been eventful for Ukraine's defense industry. The long-awaited Law on Defense Procurement was adopted. The new procurement rules are supposed to create a level playing field in Ukraine’s market for defense manufacturers, to bring more transparency and accountability to the process. Also during summer, the Ministry for Strategic Industries (Minstategprom) was created to govern Ukraine’s defense industry. Next, everyone following this sector should closely watch two things this fall to understand in which direction the defense industry reform is moving. One thing to watch is the legislative process around the defense industry in the Parliament, in particular the fate of the draft law №3822 introduced in July of 2020 to start the corporatization process of Ukroboronprom (UOP). Another important indicator is appointments to the leading positions in the industry, such as the new Director-General of UOP.

During summer a significant turnover of key officials in the sector took place. A team to run the newly created Minstrategprom was formed. Oleg Urusky, a seasoned government official, was approved by the Parliament to become the Vice Prime Minister and the Minister for Strategic Industries. Urusky hired his senior team - Vitaliy Nemylostyvyy, Valeriy Ivashchenko, Yuriy Petrovsky, Taras Kovalenko  - as deputies, and Ihor Yakovlev - as a State Secretary of the Ministry - all of whom have significant experience in the governance of state defense industry, including the work in the predecessor of Minstrategprom  -  the Ministry of Industrial Policy that existed in Ukraine before 2014. Independent Ukraine’s experience of defense sector governance has been a rather negative one, marred in corruption scandals, inefficiencies, and degradation of the industrial potential inherited from the USSR period. The Command economy to which the government officials were used to stopped working in the new post-communist reality and manual control with the lack of checks and balances in the state enterprise governance led to grand-scale corruption. Yet, a large number of government officials who inherited the Soviet culture of SOE governance do not believe in market mechanisms when it comes to the defense industry and insist on the old practice of being able to exercise direct control over companies, which includes the ability to appoint and dismiss a company’s management. UOP Board is now not operational, as the majority of its members have resigned and have not been replaced. In August, during a press-conference Oleg Urusky announced that the whole management team of UOP would be replaced. The Director-General of UOP, Aivaras Abromavičius, who led the corporatization reform and pushed for introducing anti-corruption measures and OECD standards, supported by G7 partners,  filed a resignation letter during summer. He planned to manage UOP only for a year to launch the reform and then continue overseeing it as a member of UOP’s Supervisory Board. Yet, it is unclear now if he indeed will be appointed as a Board member by the President, as well whether his team will continue the reform they initiated. Serhiy Tykhonov who was nominated by the President’s Office as Anromavicius’ successor is not known as an anti-corruption reform champion, but as a career bureaucrat, who is currently working as a civil servant of the defense department at the President’s office. It is crucial that the managerial positions of UOP and positions in its Board are occupied by reformers eager and able to continue enhancing the corporate governance of UOP in line with the OECD standards started by the Abromavicius team after President Zelensky election. 

When it comes to the legislative process that is shaping the defense industry reform, there are two opposing concepts in front of the parliamentarians today. One is to return to a Soviet idea of the ministry in charge of defense companies. Another one is a more Western-oriented approach allowing the transformation and corporatization of UOP, a conglomerate of mostly unitary state-owned companies, into several holding companies that would include joint-stock companies and limited liability companies. Even though the draft law #3822 'On reforming state-owned enterprises of defense-industrial complex' which is supposed to provide a legal framework for the UOP corporatization process was registered in July by parliamentarians from the Defense, Security and Intelligence Oversight Committee, the leadership of a newly created ministry expressed a different vision for the reform. Urusky supports a draft law introduced by a sole member of the Parliament from Yulia Tymoshenko’s Batkivshchyna party, former SSU chief, Valentyn Nalyvaychenko. Nalyvaychenko’s vision for the defense industry is that all state defense companies should be governed by one ministry, disregarding the conflict of interest when the functions of the policymaker, the regulator, and the owner are placed within one governmental body, a transformation not consistent with the OECD principles. This ministry should replace the functions of a quasi holding company - Ukroboronpron - which should be liquidated within a month after the ministry is created according to the draft law. 

On September 15 a working group was created to reconcile two above-mentioned draft laws. The group was led by Minstategprom and included Valentyn Nalyvaychenko. The result of that possible compromise between the two opposing visions would determine whether we will witness a setback in defense industry reform or a step forward. Defense manufacturers, civil society, and international partners should watch that process carefully. 

Finally, it is important to mention that the outgoing leadership of the defense industry has been open, accountable, and transparent when cooperating with the civil society and international partners. Ukroboronprom became more understandable and clear.  Will this openness and transparency be preserved?