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24 December, 2020
Draft Law on Reforming State Enterprises in Ukraine's Defense Industry: Does it Correspond to OECD Principles?
On December 16, the MPs introduced the renewed draft law #3822 developed in cooperation with the representatives of the Cabinet of Ministers and state defence conglomerate Ukroboronprom.
It should become the foundation for Ukroboronprom’s reform and transformation into transparent holdings where the system of corporate governance will be implemented. Undoubtedly, the adoption of the law is the key requirement to reform state enterprises in Ukraine’s defence industry. However, the changes need to take place in accordance with the principles of the Organization for Economic Cooperation and Development which are the best standards for corporate governance of state enterprises. This is why NAKO’s team analyzed the key provisions of the updated draft law to check how they correlate with these recommendations.   
Article 2 of the draft law recognizes the model of corporate governance of the state property in the defence industry which corresponds to OECD recommendations, and this is a positive sign indeed. However, when it comes to the powers of the state related to the governance of state defence conglomerate Ukroboronprom in the process of corporatization, the way how it is written in the document doesn’t correspond to the best practices. Here, by saying ‘state business entities’ we mean those entities which will be created after the reform of Ukroboronprom, in other words, joint-stock companies and limited liability companies.  
Thus, the Cabinet of Ministers of Ukraine (CMU) and Minstrategprom as the central executive body authorized by CMU are both defined as the ‘management entities’ which will lead to conflicts of law and blurring of responsibility. Both governmental entities simultaneously will have the same powers related to corporatization of state defence conglomerate Ukroboronprom (UOP). However, there is no clear division of what exactly belongs to the competence of CMU, and what - to powers of Minstrategprom. For example, it can relate to making decisions on UOP transformation, representation in the Commission on termination, approval of the transformation plan, executing functions of the general gatherings, definition and approval of the Supervisory Board members, etc. Under these conditions, Minstrategprom in the process of UOP transformation can potentially take over a wide range of powers related to the UOP corporatization process and avoid accountability at the same time. Thus, a vague definition of the ‘management entity’ contradicts articles D, E of Section II of the OECD Principles of corporate governance for state-owned enterprises. These articles stipulate that only one body or organization can have powers of the state as the owner. It’s noteworthy that Minstrategprom is still in the process of building up its organizational capacity whereas according to the OECD Principles the owner body has to have the required capacity and competence to effectively execute its powers. Another negative signal that we point attention to is the norm which allows defining if it’s appropriate to include independent members in the governing bodies of the companies (JSCs or LLCs). We recommend formalizing in the law that there should be independent members in such bodies, in particular, in the Supervisory Boards. One has to add, however, that the current Ukraine’s legislature stipulates that joint-stock companies must have independent members whereas there is no such a requirement for limited liabilities companies.  
Taking into consideration the existing problems with the real level of transparency and accountability of the business entities in Ukraine’s defence industry, if according to the draft law the companies limited by shares have a chance to deny engaging the independent members, it will not help facilitate the real execution of the OECD Principles. Also, the last version of the draft law #3822 has the drawbacks that we have already mentioned after the analysis of the previous version. In particular, we remind that:
  • the order of formation and the key powers of the management bodies of the company limited by shares are not clearly formalized which doesn’t fully correspond to the OECD principles; 
  • state defence enterprise Ukroboronprom receives wide powers as for governance of the companies and the ability to transfer managerial powers to another participant according to UOP’s decision;
  • the order of free transfer of assets and replacement of assets doesn’t include any mechanisms to prevent possible corruption abuse.
NAKO has already conducted a detailed analysis of these risks, and our conclusions were supported by the independent experts from the law firm Dentons within the International Lawyers Project. Now these comments are still valid.  Thus, the key NAKO’s recommendations are the following ones:
  1. to clearly define and formalize which state body or organization is the management entity and to clearly divide powers between the CMU and any other authorized state body;
  2. to formalize an exclusive list of powers of the Supervisory Board according to the article C, Section V of the OECD Principles. In particular, it should include the powers to implement and control the execution of the Code of Ethics, the Anti-Corruption Program and respect of the anti-corruption legislation, to initiate the independent audit and to publicize its results with due respect to limitations of access to information;
  3. to formalize the order of decision-making by the Supervisory Board (quorum, the voting process), the order of appointing and firing the members of the Supervisory Board, the General Director and the directors of companies limited by shares;
  4. to formalize the powers of the executive body of the company limited by shares which should not contradict the powers of the Supervisory Board;
  5. to retain independent members in the governing bodies of all companies limited by shares.
NAKO has already sent its conclusions to the Verkhovna Rada Committee on National Defence, Security, and Intelligence. NAKO stands ready to support the further discussion and enhancement of the draft law to ensure the effective reform of the corporate governance of state enterprises in the defence industry.