13 May 2021

On May 13, Ukrinform news agency hosted the round table “Restarting the state defence industry.” The discussion focused on the progress of reforming Ukraine’s defence industry, challenges and threats on the path to building an effective corporate governance system, and property and social aspects of transforming state-owned defence enterprises.

The discussion on reforming state-owned enterprises in Ukraine’s defence industry was joined by Olexandr Zavytnevich, Verkhovna Rada Committee on National Security, Defence, and Intelligence; Yuriy Husyev, Director General, Ukroboronprom; Roman Bondar, First Deputy Director General, Ukroboronprom; Yuriy Pashchenko, Director of SE Scientific and Production Complex Iskra; Andriy Boitsun, Head of Corporate Governance, Kyiv School of Economics, Gleb Kanevsky, Chair of the expert organization StateWatch; and Ihor Levchenko, Head of the Strategic Modelling Section, CACDS. The discussion was moderated by Olena Tregub, NAKO Executive Director.

On May 14, the Verkhovna Rada Committee on National Security, Defence, and Intelligence will consider amendments to Draft Law No. 3822, which should become the foundation for transforming defence industry enterprises and introducing a corporate governance system in accordance with the best international standards. According to NAKO’s analysis, the current version of the draft law contains a number of risks that may threaten the quality of reform and therefore needs to be finalized for the second reading. One of these challenges is to identify the body responsible for managing transformed enterprises. This body is not clearly defined in the version supported by Members of Parliament (MPs) in January 2021.

“The owner of Joint Stock Companies will be the state, represented by the Cabinet of Ministers. This amendment was supported by the Working Group and will be defended tomorrow at the committee meeting,” said Olexandr Zavitnevych, Chair of the National Security, Defence, and Intelligence Committee.

According to the OECD Guidelines, combining the functions of the owner, regulator, and policy-maker in one body is unacceptable because this creates conflict of interest risks. Explaining this argument, Andriy Boytsun, Head of Corporate Governance at the Kyiv School of Economics, drew a parallel with football, “When a Football Federation owns one of the football clubs, it can ‘tip’ this club in one direction or another, or it can even ask it to lose a certain match,” the expert noted.

Recalling high-profile corruption scandals in the Concern related to high-ranking officials, Ukroboronprom Director General Yuriy Husiev stressed, “The corporate management system allows you to install fuses so that there is no desire to use the defence industry for political purposes or for the purpose of enrichment. It is necessary for the defence industry to work in the interests of the state and the Armed Forces of Ukraine.”

The public and experts draw attention to the insufficient guarantees of independence of the supervisory board, one of the key bodies in the corporate governance system. This is the second drawback of the current version of the draft law, which, in particular, is mentioned in the Organization for Economic Cooperation and Development’s (OECD) latest review in relation to Ukraine. This refers to the insufficient number of independent members and the procedures by which they will be elected and appointed. “We need to decide whether we are doing this reform according to the OECD principles or taking into account the OECD principles? We have already seen semi-solutions in other state-owned enterprises. They clearly demonstrated that if 3 holes out of 5 are ‘patched up’ in a sinking ship, the ship will still sink, it will just take longer,” said Mr. Boytsun.

Olexandr Zavytnevich noted that the process for selecting supervisory boards is extremely important. According to him, the Cabinet of Ministers will be responsible for creating mechanisms to select independent members of the supervisory board and state representatives. The Chair of the National Security Committee also said that the working group supported the amendment, which introduces a more transparent mechanism for monitoring the movement of assets. It is assumed that the public and journalists will be able to monitor property issues, since all relevant documents must be published in the public domain. According to Mr. Zavitnevych, it was the issue of assets that caused one of the biggest discussions among MPs, because Draft Law No. 3822 actually provides unprecedented opportunities for Ukroboronprom in property management issues that no other state-owned enterprise has ever had. “I have only one explanation – we simply do not have time to reissue permits, licenses, and contracts.”

This thesis was supplemented by Roman Bondar, First Deputy Director General of Ukroboronprom. He explained that the advantages laid out in the draft law are procedural. “We pay great attention to ensuring that there is no negative impact on operational activities during corporatization, so as not to disrupt the enterprises’ ability to create defence products.” He spoke in detail about the key tasks for the next year: forming a supervisory board, electing a new director general, and launching the transformation of enterprises, taking into account the organizational characteristics of all the Concern’s enterprises.

One of these enterprises is Iskra, which is not able to create joint ventures and production facilities or invest in high tech, like all other members of the Concern. “It’s no secret that a third of the buildings of a plant like Iskra are pigsties,” stated Yuriy Pashchenko, Director of this research and production complex. However, the enterprise’s biggest problem is its ownership form – it is a Government enterprise (the so-called kazene). According to Mr. Pashchenko, this type of ownership and lack of corporate governance has caused Iskra to lose many investment opportunities and projects, and the current legislation does not solve any of these problems. “There is no mechanism for turning a kazene enterprise into a joint-stock company. Only Draft Law No. 3822 provides this opportunity.”

Hlib Kanievsky, Chair of the expert organization StateWatch, also stressed the need to adopt this bill. He gave examples of factories in Lviv and Kharkiv that cannot work effectively due to legal restrictions and lack of funds from the state. He also mentioned the “Iron Dome” system, which recently demonstrated the Israeli defence industry’s capabilities. “Can Ukraine’s defence industry create something similar? The potential exists. But there are specific legal and financial restrictions that deter Ukraine from such a leap forward.” He explained that this system was developed in a public-private partnership, while Ukrainian state-owned enterprises do not have an opportunity like that. “The current law on Ukroboronprom, which was created by the Yanukovych-Azarov team, did not provide for such international cooperation, so that investments from NATO countries would not enter Ukraine.”

NAKO Executive Director Olena Tregub stressed that Ukraine’s international partners support reforming the country’s defence industry, and the public will continue to monitor the progress of this reform. “I hope that when the law is adopted and it begins to be implemented, we will carefully monitor together – the public, the authorities, and representatives of manufacturers – what will happen next.”

We express our gratitude to the Embassies of Great Britain and France in Ukraine for their support in holding this round table.