UKRAINE SINCE THE ORANGE REVOLUTION: A Business and Investment Review:
Consultant editor: Dr Marat Terterov
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Publisher’s note Every possible effort has been made to ensure that the information contained in this publication is accurate at the time of going to press and neither the publishers nor any of the authors, editors, contributors or sponsors can accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editors, authors, the publisher or any of the contributors or sponsors. Users and readers of this publication may copy or download portions of the material herein for personal use, and may include portions of this material in internal reports and/or reports to customers, and on an occasional and infrequent basis individual articles from the material, provided that such articles (or portions of articles) are attributed to this publication by name, the individual contributor of the portion used and GMB Publishing Ltd. Users and readers of this publication shall not reproduce, distribute, display, sell, publish, broadcast, repurpose, or circulate the material to any third party, or create new collective works for resale or for redistribution to servers or lists, or reuse any copyrighted component of this work in other works, without the prior written permission of GMB Publishing Ltd. GMB Publishing Ltd. 120 Pentonville Road London N1 9JN United Kingdom www.globalmarketbriefings.com This edition first published 2006 by GMB Publishing Ltd. © Marat Terterov Hardcopy ISBN 1-846730-04-X
E-report ISBN 1-846730-05-8
British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library
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Contents Acknowledgements
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Editorial Contributors
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1. Editor’s Introduction: Roses, Oranges and Foreign Investors Dr Marat Terterov,
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2. The Political and Economic Environment in Ukraine Yevgen Zinovyev, Macroeconomics and Industries Expert, Raiffeisen Bank, Ukraine
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3. Recent Legal Developments Vladimir Sayenko and Partners, Kyiv,Ukraine
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4. Recommendations for Improvements in the Investment Climate European Business Association, Ukraine
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5. An Outlook and Ratings for Investing in Ukraine’s Regions Markiyan Dacyshyn, Director, Ukrainian Economic Think-Tank, Institute of Reforms
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6. Dragon Capital Case Study
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Acknowledgements The editor would like to acknowledge the very helpful support provided for this report and further sources of information, including: Dr Sergei Maslichenko (The Ukrainian Centre for Economic and Legal Analysis) The BISNIS service of the US Department of Commerce The European Bank for Reconstruction and Development The Stefan Batory Foundation (Warsaw, Poland) The Economist Intelligence Unit The Moscow Times The Financial Times The Russian News Agency Novosti Radio Free Europe The Carnegie Endowment The Nixon Centre The RAND Corporation
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Editorial Contributors THE EUROPEAN BUSINESS ASSOCIATION – this non-governmental, non-profit, public organization was established in 1999. It currently brings together 499 European, international and Ukrainian companies and acts as platform for information exchange and dialogue with Ukrainian authorities. The Association sees its core mission as assisting European integration of Ukraine by advocating and assisting in the harmonization of Ukrainian laws and business practices with those of the European Union. The EBA offers its members: collective advocacy of their interests before the central and local authorities of Ukraine, foreign and international organizations; a voice in the EU policy-making process through strong working links to the European Commission and the national EU embassies in Kyiv; regular information support on developments affecting business in Ukraine; networking opportunities and social events - chances for the business community to meet informally. Contact details: The European Business Association 1st floor, 1A Andriyivsky street, Kyiv, 04070, Ukraine Tel.: (380 44) 496-0601 Fax: (380 44) 496-0602 E-mail:
[email protected] http://www.eba.com.ua President Bjorn Markstedt (AVIS Ukraine) Vice Presidents: Jorge Intriago (PricewaterhouseCoopers), Alexander Pisaruk (ING Bank Ukraine) Executive Director Anna Derevyanko. RAIFFEISENBANK UKRAINE – is a 100% subsidiary of Raiffeisen International, the holding company for most important subsidiaries of Raiffeisen Zentralbank Osterreich Aktiengesellschaft (Vienna, (RZB) in Central and Eastern Europe. RZB is the central institution of the Austrian Raiffeisen Banking Group, the country's most powerful banking group. RZB operates, via Raiffeisen International, a network of 16 subsidiary banks with approximately 2400 banking outlets in 16 markets of the region. On 20 August 2005, Raiffeisen International announced the acquisition of Bank Aval, the second-largest bank in Ukraine. This deal was closed on 20 October after the granting of all necessary approvals by the relevant authorities. With this acquisition, Raiffeisen International became the country’s market leader. Yevgen Zinovyev is Macroeconomics and Industries Expert, the Risk Management Division at Raiffeisenbank Ukraine. Prior to his engagement with the bank, he spent two years studying Economics at State University of New York at Albany. With Raiffeisenbank he is involved in political, macroeconomic, and industry analyses.
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Contact details: Leonid Zyabrev Public Relations Manager Raiffeisenbank Ukraine 43 Zhylyanska St, Kyiv Ukraine - 01033 Tel: +38 (044) 247 45 74 (int. 70-66) Fax:+38 (044) 490 05 36
[email protected] URL: http://www.rbua.com/ SAYENKO KHARENKO – is one of the leading Ukrainian business law firms specializing in complex cross-border and local matters. The firm has especially strong corporate, banking and finance, and capital markets capabilities. It is highly recommended by the international and local legal directories, including the most recent editions of Chambers Global (2006) and IFLR 1000 (2006). The clients of the firm include many of the largest multinational corporations and financial institutions, including Fortune 500 and Forbes International 500 companies. The firm closely works with and regularly acts as local counsel to major US and European law firms in transnational projects. During the last year the firm has handled over two billion dollars worth of financial transactions, including the first subordinated debt offering by a Ukrainian bank; the largest Eurobond offering by a Ukrainian financial institution; the largest capital markets transaction for investment in local currency; and some of the largest syndications to Ukrainian companies guaranteed by the Government. The firm has serviced many of the most important Ukrainian cross-border M&A transactions, including recently the due diligence of one of the top five Ukrainian banks and Krivorozhstal steel mill. Last year the firm's competition lawyers obtained clearance for over a dozen major multi jurisdictional mergers and acquisitions and successfully defended Western Union against Antimonopoly Committee's claims regarding an abuse of dominant market position, which was the largest-ever claim for a violation of competition law in Ukraine. Contact details: Sayenko Kharenko, Attorneys at Law Tel.: + 380 44 537-1000 Fax: + 380 44 461-4060 E-mail:
[email protected] Web: www.sayenkokharenko.com Contact: Vladimir Sayenko, Partner THE INSTITUTE OF REFORMS – is a Ukrainian non-governmental economic think tank founded in 1997. A national research and educational organization, we are dedicated to creating a free and open market in Ukraine. We work to foster dialogue at every level of government about the need for economic reform. Through our independent thought leadership and outreach, we seek to lower taxes,
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keep government out of business, and bring transparency to regulatory processes. We support a fair marketplace where businesses of all sizes can compete equally. We believe an economy that is attractive for Western investors will bring new jobs and money to Ukraine. Institute for Reforms is the only Ukrainian think tank working in every region of Ukraine across seven programs: • EUROPEAN INTEGRATION AND WTO ACCESSION – Provide support and information to citizens about key issues in the field of EU enlargement • INVESTMENT CLIMATE ASSESSMENT – Evaluate factors impacting investment climate in Ukraine • LOCAL AND REGIONAL DEVELOPMENT – Provide ways to decentralize power, allocating resources to local governments • PRIVATIZATION AND CORPORATE GOVERNANCE – Analyze status of privatization efforts across Ukraine • SMALL BUSINESS DEVELOPMENT – Recommend actions to stimulate private enterprise • TAX POLICY – Issue tax structure analyses and work for tax reduction Contact details: Markiyan Dacyshyn, Director Institute of Reforms E-mail:
[email protected] http://www.ir.org.ua www.ipa.net.ua
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1. EDITOR’S INTRODUCTION: ROSES, ORANGES AND FOREIGN INVESTORS
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kraine has drawn much attention in the international media since the tumultuous events of November 2004 – January 2005 have ushered in a new sense of identity building in the country – the era of the so-called Orange Revolution. During the latter stages of the regime of President Leonid Kuchma (1994–2004), Ukraine had developed the reputation of a newly independent democratising state, with notable economic potential, but a country stymied by a closed circle of inward looking ruling elites, accountable primarily to themselves and exploiting the national economy as if it were their own personal fiefdom. Corruption and nepotism at the highest levels of business flourished in both perception and reality, critics of the regime in the media were often dealt with ruthlessly, while the country’s emerging economy was attracting miserly amounts of foreign direct investment (FDI) compared to regional levels. Foreign investors conducting business in Ukraine often found themselves stifled by excessive government intervention in their commercial life, lack of transparency and predictability in the rules and institutions governing business – a difficult business climate overall. It comes as little surprise, therefore, that despite the substantial optimism that Western governments and foreign investors held for its development into a fully-fledged market economy and democratic state,
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Ukraine had attracted significantly less foreign investment, not only in comparison to other transitional economies in Central and Eastern Europe, but had also attracted amongst the lowest levels of FDI per capita amongst other former Soviet Republics. However, the rallying of the Ukrainian electorate behind the current president, Viktor Yushchenko, during last winter’s election campaign was not the result of low levels of FDI during the previous decade, nor due to the challenging nature of Ukraine’s investment climate for foreign investors. Rather, it is worth noting one of the paradoxes of Ukraine’s political economy during the latter stages of Kuchma’s presidency: the fact that the economy was finally starting to grow impressively (topping 12% in 2004) and that FDI was starting to pick up (reaching $2 billion in 2004, compared to around $10 billion for the period approximating the entire previous decade), at the same time as the vociferous public demonstrations against the government such as those taking place during the Orange Revolution. Countless ordinary Ukrainians – both businessmen and average citizens - could rightly have been asking themselves into whose pockets the benefits of the country’s impressive economic performance had gone? Indeed, it was the pervasive level of disenchantment with public mismanagement and low quality of governance felt by overly significant volumes of Ukraine’s population, both sparked and institutionalized by the fraudulent first round of
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presidential elections, that brought countless thousands of Ukrainians to Kyiv’s now famous Maidan (independence square) in November 2004. It is now axiomatic that the would-be leaders of the “New Ukraine”, namely, the widely popular presidentelect Yushchenko and his charismatic acolyte, Yulia Tymoshenko, rode-the-wave of the public vote of no-confidence in the Kuchma regime and its nominated successor, Viktor Yanukovych, and their ebullient campaigning during Kyiv’s cold winter days resulted in the emergence not only of a new government in Ukraine but, as in ex-Soviet Georgia a year earlier, genuine expectations from the major part of the population that their lives would change for the better. In a domain traditionally dominated by pessimism and gloom, a new optimism seemed to permeate through the political culture of post-Soviet Ukraine, as Orangemainia swept Kyiv and other (at least the Central and Western) parts of the country in early 2005.
Legitimacy: at the Heart of Government Legitimacy is often an uneasy concept for governments to deal with in any type of political system, be it democratic, democratising or authoritarian. As was the case with Georgia’s Rose revolution in late 2003, much of the legitimacy of the newly inaugurated Yushchenko government would lie in its ability to reverse the flagrant and widespread incidence of state sponsored corruption and business cronyism, as well as promoting better governance overall. In Georgia, the government of new president Mikheil Saakashvili had made some notable progress in reducing corruption and promoting better practices in governance during its first year in office.
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In the case of Ukraine, however, a much larger country of near 50 million people where the ordinary civil servant has been nurtured on a rent-seeking culture, changing the mentality of a society so as to reduce middle level bureaucratic corruption would not be a task for the fainthearted. Nevertheless, the new government’s rhetorical position of officially seeking to move Ukraine closer to mainstream European institutions embodied substantial hope that Ukraine’s Soviet style rentseeking economic model could be superceded by internationally acceptable practices in the future. The principle of separating business from politics, a formula flagrantly missing from Ukrainian economic policymaking in the Kuchma years, was promised by the country’s new government and needed to be adopted. State patronage doled out for selective private sector interests was one of the characteristics of Ukraine’s business culture during the Kuchma years. Annulling such practices was one of the cornerstones to the new government’s policy promises, and together with its increasingly pro-European policy rhetoric, provided a major source of optimism for foreign partners contemplating working with Ukraine in the both the government and business sphere. In summing up the factors which were the primary drivers in Viktor Yushchenko’s camp sweeping to power during the Orange Revolution as briefly introduced above, some of the major policy objectives that Ukraine’s new government set out to achieve as of early 2005 included: Combating corruption at all levels of society and primarily within the institutions of government. Pushing through with administrative reform of public sector organizations would be
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a major priority within this context. Combating cronyism in business which had become pervasive during the Kuchma years, as symbolized by the state’s cutprice privatization of Ukraine’s major steel producer, Kryvorizhstal, in June 2004 to Ukrainian oligarchs known to be close to the top echelons of government. Driving Ukraine towards greater integration with European political and economic structures and the international economy, namely institutions such as the European Union (EU) and the World Trade Organization (WTO). However, Ukraine’s new out-reach towards Europe should not come at the expense of deeply established ties between Ukraine and Russia. In parallel to moving Ukraine closer to Europe, more concerted efforts would be made to attract foreign investment to Ukraine, by way of levelling out the rules and regulations for doing business, making these more predictable and transparent, as well as through efforts to improve the direction of corporate legislation, promote good economic management and fiscal stability, reduce excessive regulations on business and to strengthen the nature of tax administration, thereby improving the investment climate across the board for both foreign and domestic investors alike. Furthermore, it would be important to ensure that the benefits of the high economic grown Ukraine was experiencing in recent years would be felt in a broader manner by society as a whole, with adequate spend-
ing into a multitude of social programmes being one of the government’s main priorities Given the new levels of hope and optimism for the future that such vast numbers of Ukrainians now felt (as well as the disenchantment felt by those in Ukraine’s “blue camp” – supporters of Kuchma’s incumbent, Viktor Yanukovych, many of whom felt that Ukraine would now be lost to a government captured by the interests of Western neo-imperialists), the legitimacy of the leaders of Ukraine’s Orange Revolution would be at stake if the government was unable to deliver on its major policy objectives within a reasonable time span. In the remainder of this article, therefore, we will turn our attention to evaluating the performance of the new government, referring the discussion, where possible to issues relevant to foreign investors contemplating doing business in Ukraine.
THE ORANGE REVOLUTION IN HINDSIGHT: PERFORMANCE OF THE NEW GOVERNMENT Social Perception and Realities On November 20 2005 Kyiv marked the first year anniversary of the Orange Revolution. The government of Ukraine supported the celebrations taking place on Kyiv’s Maidan, which included symbolic soup kitchens and the erection of a huge stage commemorating the events of 12 months earlier. However, these celebrations were a far cry of the atmosphere of November 2004. Yulia Tymoshenko, the heroine of the revolution, has fallen out politically with President Yushchenko, leading to her dismissal
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from government in September. A similar fate met with other members of Yushchenko’s cabinet, and many of his most high profile supporters from one year earlier have likewise left the government. Most of the dismissals were surrounded by corruption allegations, similar in nature to those which haunted the Kuchma regime. Elements of the media which supported Yushchenko during his election campaign, have become increasingly critical of the corruption allegations associated with the new regime, causing more than a few tense moments between the press and the government. Ukraine’s Pora movement, the civil society youth group which organized many of the protests during the Orange Revolution, has become largely disenchanted with the country’s new government, and has itself split into factions – one of which intends to run as an independent political party in the March 2006 parliamentary elections. Society’s perceptions of Yushchenko’s current government, as of September led by Prime Minister Yuriy Yekhanurov, have slumped from the obvious highs immediately following the Orange Revolution and are, for the most part, currently quite low. A recent opinion poll conducted on several thousand Ukrainians in October revealed that just 12.3% of respondents said they would vote for Yushchenko’s Our Ukraine party in next year’s parliamentary elections. Up to 20% claimed they would instead vote for former Prime Minister Yanukovych and his Regions Party, while nearly 14% were planning to vote for the Yulia Tymoshenko bloc. Further opinion polls demonstrate that an increasing number of Ukrainians believe that under the current government the country is moving in “the wrong direction” (or, for some, a direction contrary to what they perceived during the Orange Revolu-
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tion) and many (both supporters and opponents of the current government) claim that there is little or no difference between the previous and current ruling elites. The new government has, for example, raised public sector wages and salaries early in 2005, but its economic management had fuelled inflation and higher prices followed, making life as difficult for many Ukrainians as during the previous regime.
A Fragmented Policy Making Process Although the Orange Revolution seemed to create an outward sense of political unity during last winter’s presidential elections, the emergence of several different power blocs within the institutional framework of the new government undermined any genuine semblance to coordinated policymaking that the government could initiate. Some initial differences in the policy-making approaches of the new government were already becoming evident as early as February 2005, when President Yushchenko and Prime Minister Tymoshenko appeared to contradict each other in their respective positions over the government’s intent to review some of the dubious privatizations of the Kuchma years. The populist Prime Minister, whose calls to “put bandits in prison” (in reference to Ukraine’s Kuchma era oligarchs who allegedly made some of their fortunes through such privatizations) were met by rousing applause during the Orange Revolution, created the impression that hundreds of privatizations would be reviewed. The President, however, gave the impression that only some of the most conspicuously fraudulent privatizations would be reviewed, and that Ukraine’s business community would not be subject to a state-sponsored ‘witch-hunt’.
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Needless to say, with both President and Prime Minister being capable of mobilising their bands of supporters within government and business community, contradictory positions over policy issues (from leading members of government) such as review of privatizations, debates over Ukraine’s entry into the WTO, administrative and other areas of needed reform and economic management led to the emergence of competing interests amongst Ukraine’s new ruling elites and the emergence of different centres of power within the government. Political analysts identified the emergence of four major centres of power within the new government: the Presidency and its Presidential Secretariat; the Cabinet of Ministers headed up by Prime Minister Tymoshenko; the Verkhovna Rada (Parliament) led by its Speaker, Volodymyr Lytvyn; and a bloc emerging around Petro Poroshenko, one of the business figures closely linked to Yushchenko during the Orange Revolution, who was appointed as the head of the National Security and Defence Council. The emergence of the different power blocs within the Ukrainian government soon after the Orange Revolution prevented the state from acting in a coordinated manner, and policymaking – particularly in the economic sphere – often became drowned in diatribes between the competing power blocs. The Cabinet of Ministers often failed to receive the support of the Parliament when it initiated key reform oriented legislations, while different high profile members of government often accused each other of lobbying their own individual business interests rather than promoting policy making. By the middle of the year, with the initial euphoria of the Orange Revolution now a thing of the past, the lack of a clearly defined, consistent and coordinated strategy for Ukraine’s
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development by the country’s new ruling elites was ushering in the stark realities of Ukraine’s political predicament. Nation-wide polls were by that stage showing the government, led by a President who had commanded almost hero-like status only months before, was clearly losing its popularity amongst the mainstream population. The primary reason for this downturn was precisely that the government had failed to promote any of the meaningful socio-economic reforms and foreign policy initiatives that it had seemed certain to embark upon after it came to power. Furthermore, given the manner in which the competing factions within government prevented the development of coordinated policy making, it now seemed highly unlikely that any further noticeable government policy initiatives could be expected until after parliamentary elections would take place in March 2006.
Polls show popularity of the government declining The government’s popularity, which according to a nation-wide poll taken by the Razumkov Centre, stood at 52 per cent in April 2005, fell to just 37% in August, indicating that well under 50% of Ukrainians now felt that the new authorities were better than the old ones. The Razumkov Centre poll also showed that more Ukrainians are holding the belief that the country is heading into the wrong (social, political and economic) direction (43 per cent in August compared to just 23 per cent in April). Also, according to the poll results, the number of Ukrainians who think that the country’s economy has deteriorated under the government of Viktor Yushchenko is more than double the number of those who think that it has improved – 41.5 per cent versus
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20.5 per cent (compared to 19 per cent versus 27 per cent in April). Perhaps the only positive development coming from the Razumkov Centre’s poll was the fact that it indicated that Ukrainians continued to believe that the level of democracy and media freedom under Yushchenko’s rule increased rather than decreased (38 per cent versus 20 per cent on democracy and 46.5 per cent versus 14.5 per cent on press freedoms). Perhaps the biggest problem for the country’s political development, however, was that Ukraine’s new ruling elites were not only unable to convince Ukrainians that they were combating corruption, but numerous allegations emerged where leading members of the new government were themselves getting tangled up in corruption scandals. Whilst it was promised by the new elites that Ukraine’s members of government were to be selected on the basis of their technical abilities, leading members of President Yushchenko’s entourage were duly being accused of abusing their political positions to promote their business interests, causing a number of political scandals during the summer. In fact, by late summer corruption, in fact, had become such a recurring theme in Ukraine’s political life that a crisis seemed just around the corner. It came in early September, when Oleksandr Zinchenko, one of the political architects of the Orange Revolution and subsequently head of President Viktor Yushchenko’s administration, tendered his resignation. Zinchenko’s resignation was a sign of protest against what he described as pervasive and blatant practices of corruption by leading members of the Presidential Administration, particularly Petro Poroshenko and Oleksandr Tretyakov, Yushchenko’s first assistant, who were together accused of forming a shadow government and promoting a “Byzantine” system of
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management. Zinchenko’s resignation led to a major crisis within the coalition of alliances which held the new government together. It was followed by a number of other resignations and dismissals, including those of Poroshenko and Prime Minister Tymoshenko. After a series of crisis negotiations and some further tense moments between the Presidential Administration and the Parliament, Viktor Yushchenko managed to secure the necessary support for parliamentary approval of Yuriy Yekhanurov as the new prime minister on September 20th. Yekhanurov is perceived as a technocrat with few direct ties to business, who was, however, chairman of the State Property Fund from 1994-97, during which time he oversaw Ukraine’s mass privatization programme. As the first deputy to then-prime minister Yushchenko in 2000-2001, he oversaw the smooth workings of government and is perceived to be loyal to Viktor Yushchenko. However, the new prime minister has taken on a challenging post at a difficult time, however, and faces a huge task in striking a balance between the consolidation of power blocs and fragmentation of Ukraine’s political environment following the September government crisis.
The Economy The overall performance of Ukraine’s economy failed to keep pace with the impressive growth achieved during 2004. The economy grew by just 3.7 per cent during the first 7 months of 2005, and was forecast to reach 4.3 per cent by year’s end. This compared to annual GDP growth of 12.1 per cent in 2004 and 9.4 per cent in 2003. Furthermore, the economy experienced a noticeable decline in industrial production and investment during the year, while the positive
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trade balance that Ukraine had developed during 2004 has eroded from nearly $4 billion to a little less than $2 billion during the first half of 2005. Critics of the previous government of former Prime Minister Yulia Tymoshenko primarily placed the blame of Ukraine’s startling macro-economic deterioration on the government’s economic policies, including: Creating investor uncertainty and under-mining property rights by initiating a widespread public discussion of nationalization of privatized companies and their onward sale to new investors in so-called re-privatizations; Substantial increases in the tax burden (to some 5%-6% of GDP) in order to finance social welfare spending and public wages; Far reaching government intervention in the economy which has included measures such as attempts to regulate petrol prices (as well as prices for meat and grain), reinforcing state monopolies and doubling the railway tariffs for metal freight; Lower levels of government investment in the economy due to increasing social expenditures. Some analysts, such as Anders Aslund of the Carnegie Centre in Washington, have referred to the economic programme of Tymoshenko’s government as a form of ‘socialist populism’, which has included frequent public attacks on well known, individual businessmen in a style not dis-similar to the case of the Russian state’s attacks on Mikhail Khodorkovsky and his Yukos oil company. However, we should note that as in the case of Russia’s ‘easy years’ of high economic growth on the back of
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favourable global energy prices, Ukraine’s growth during 2004 was also driven by a commodity export boom, particularly in metallurgy. Prices on the world markets for Ukraine’s chief commodity exports have been less favourable in 2005, contributing to a deceleration of growth rates and a decline in the previously favourable trade balance. Public sector wage increases taking place during 2005 have also fuelled higher levels of inflation, reaching almost 15 per cent for the year up to August – another aspect detrimental to the government’s economic management. However, a combination of wages-prices inflation has caused some alteration in the structure of Ukraine’s economy, fuelling increased domestic demand and elevating domestic consumption to the position of key driver for economic growth in 2005.
Re-privatizations Despite the poorer economic performance during 2005, there have not been any public demonstrations demanding that economic growth be restored to the levels of the previous years, nor has there been much public outcry against Tymoshenko’s attacks on the oligarchs from the Kuchma era and the nationalization of some of their assets acquired previously through scandalous privatizations. Although the government’s talk of re-privatization is bound to have caused some uncertainty amongst investors considering business in Ukraine during the year, it is becoming evident now that the re-privatization discourse has been limited to a single litmus-test, through which by all initial accounts the government seems have to come through positively. That litmus-test has been the nationalization and re-privatization of Kryvorizhstal, perhaps the main talking point in
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Ukrainian business during 2005, a brief account of which is given below. Kryvorizhstal is the flagship of Ukraine’s steel production, employing 56,000 people and producing around 20% of Ukraine’s entire metals output, or some 8 million tons of steel per year. In June 2004 Kryvorizhstal, a Ukrainian state-owned enterprise dating from the Soviet era, was sold through a privatization to a company owned by the son-in-law of the then President Kuchma, for a little under $800 million. The sale price was substantially below independent valuations of the company, as well as other bids submitted during the privatization tender. The sale of Kryvorizhstal in June 2004 aroused vigorous protests both within Ukraine and abroad and became the symbol of the blatant business corruption of the Kuchma years. Reversing the Kryvorizhstal privatization became one of the campaign shibboleths of the Orange Revolution elections and was the main item of policy implementation which the Ukrainian government had in mind when it spoke of revising some of the country’s more controversial privatizations. Kryvorizhstal was returned to state ownership during the summer –after a sequence of legal and administrative procedures by the Commercial Court of Appeal in Kyiv, which finally ruled the June 2004 privatization illegal – and was subsequently slated for a new privatization round during the autumn. It became evident that the government was to make a show-case of the re-privatization of the company when it was announced that the privatization auction would be broadcast live on Ukrainian television on October 24th., demonstrating the new levels of transparency that the government was trying to adopt. Kryvorizhstal was offered at a starting price of $2 billion and the bidders included
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Mittal Steel (the world’s largest steel producer), France’s Arcelor (which combined with Ukraine’s Industrial Union of the Donbass) and a consortium of Russian-Ukrainian steel companies. The auction was won by Mittal who ended up paying $4.8 billion for a 93.02 per cent stake in Kryvorizhstal – a massive influx of FDI into the Ukrainian economy and a major policy coup for the Yushchenko government. The sale price was some $4 billion more than the price paid for the company during the June 2004 privatization and outstripped significantly the government’s targets for revenues earned from privatizations during 2005, which were set at $1.4 billion.
FDI What was – in effect - the second privatization of Kryvorizhstal was also the largest ever foreign investment made into Ukraine, roughly equating to some 20% of this year’s anticipated entire budget revenues. Given the serious nature of the investment by Mittal Steel into the Ukrainian economy, where the world’s largest steel producer has paid such a significant price for a Ukrainian government asset, it is not difficult to suggest that 2005 is turning out to be a very favourable year in Ukraine’s FDI experience. Furthermore, the Kryvorizhstal auction took place just days after Raiffeisen International, the East European arm of the Austrian banking group, completed its acquisition of Aval, Ukraine’s second largest bank controlling some 8.7% of total banking assets in the country. Raiffeisen initially acquired a majority 93.5% stake in Aval in August and, upon completing its acquisition of the Ukrainian bank in October, injected another $1.03 billion of FDI into Ukraine’s economy. Furthermore, it
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was recently confirmed that other foreign banks are in advanced stages of negotiation for the acquisition of other Ukrainian banking assets, including Ukrsotsbank and Ukrsibbank, the third and fourth largest Ukrainian banks respectively. Thus, while analysts cite contradictory government policies resulting in minor inflows of investment in the initial six months or so after the Orange Revolution, in the space of just a few short months Ukraine has attracted more than half the entire cumulative FDI stock it has attracted during the entire period since the collapse of the Soviet Union: close to $6 billion in FDI has flowed into the Ukrainian economy between August-October 2005, compared to less than $10 billion during the remainder of the post-Soviet period. FDI from Russia continued to flow into Ukraine during 2005 and the country continued to hold the position of one of the most important destinations for Russian investment within the CIS market. In midNovember, for example, Russia’s number two mobile phone firm, VimpelCom, entered Ukraine’s fastgrowing telecommunications market through the acquisition of Ukrainian mobile RadioSystems (URS), a relatively small Ukrainian mobile tele-communications operator for $231.3 million. Dynamic Russian corporations, often flush with funds and less averse to risk than more cautious investors in the West, have in recent years seen in Ukraine’s fast-growing consumer market quite an attractive investment opportunity and, despite the outwardly more European stance taken by president Yushchenko and his governments in 2005, Russian investment has continued to proliferate in the country.
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Investment Climate Although the new government of Ukraine has sought to present itself as a champion of international standards in governance, while it has put forward business friendly legislation to the Ukrainian parliament, and while 2005 is already proving to be far and away the most successful year for FDI that independent Ukraine has witnessed, the country still has a mountain to climb before an investment climate commensurate to EU countries begins to prevail within its territories. As already stated, fighting corruption by reforming the public administrations, and ending the practice of using political power to promote selective interests in the private sector were amongst the major public priorities of Ukraine’s new government. In respect of the latter, Ukraine’s crisis of government during September and President’s Yushchenko’s dismissal of Prime Minister Yulia Tymoshenko and several other supporters of the Orange Revolution, underscored the fact that some of the president’s major allies who had been rewarded with senior government positions, had once again succumbed to the lure of confusing public and private interests. By official accounts, the new government has dismissed some 18,000 civil servants in an effort to reform the public administration, and has likewise carried out reforms of the customs administration, reportedly a major source of corruption under the previous political regime. However, despite these efforts, as late as November 2005 President Yushchenko spoke of the ‘systematic crisis’ in Ukraine’s economy, where the president cited administrative interference as the main cause of the economic problems (Russian New Agency Novosti, Kyiv, November
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9th 2005). Yushchenko added that ‘Administrative intervention in the country’s economy has been a serious setback in the country's development during the last nine months. We must face up to this. This interference has caused a systemic crisis’. The president’s sentiments in relation to the government’s failure to stamp out grass roots corruption and excessive state intervention in the dayto-day lives of businessmen appear to be shared by Ukraine’s foreign investor community. In October 2005, the European Business Association in Kyiv, a lobby group representing the interests of some of Ukraine’s dominant foreign investor interests, stated that: In order to build sufficient private sector confidence to revive investments, the government will need to give stronger signals that it is addressing one of the main concerns of the private sector: that is, the concern that the Ukrainian Government still retains many of the characteristics of Soviet public institutions overloading the private sector with heavy and unpredictable demands and requirements, including heavy regulations and interventions in the workings of the market. Furthermore, as confirmed in a study by the EBRD and the World Bank evaluating the business environment in CIS countries during 2005, tax administration and the (state’s) regulatory burden rank among the top three obstacles to doing business in Ukraine. As will be discussed in more detail in the ensuing part of the report, legislative changes taking place during the year did not reflect the expectations of the business community: the business code of Ukraine was neither abolished nor amended to remove the inconsistencies with the Civil Code of Ukraine, whilst a lot of expected legislation including draft laws on Joint Stock Companies, the Securities and Stock Market, Cur-
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rency Regulation, Real Estate Tax and the Tax Code were not adopted. Another government measure of concern for investors in Ukraine this year was the government’s abrupt removal of special economic zones (SEZs) and the lack of consultation with the investor community in the lead up to this measure. This concern is summarized in the following observation, from a commentary on Ukraine’s investment climate provided by the BISNIS service of the US Department of Commerce: Ukraine created special economic zones (SEZs) in the mid-1990s to encourage development in certain regions. The SEZs were aimed at providing incentives, such as tax breaks, to foreign businesses investing in Ukraine. In March 2005, Ukraine withdrew all privileges associated with SEZs through a revision of the 2005 budget. Removal of SEZs was a condition to inclusion in WTO and eventually also in the European Union (EU) free trade area. Moreover, some expert observers point out that while SEZs benefited specific regions of Ukraine, the problems associated with their existence, especially tax evasion by large Ukrainian businesses, provided legitimate reasons for their removal. However, negative perceptions of this action arose because, while the elimination of SEZs was not completely unexpected, there was apparently no discussion with established businesses before their removal. Also, revocation of SEZs reportedly adversely affected many existing businesses and led to some foreign businesses deciding not to invest in Ukraine. The commentary from BISNIS goes on to observe that: Although Ukraine does seem to be making progress, many issues concerning lack of effective law enforcement, transparency, and excessive registration and compliance requirements remain unresolved. The foreign business community in Ukraine has reportedly been disenchanted by the failure to significantly strengthen the rule of law and eliminate some government regulatory
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procedures. A survey conducted in July 2005 by Ukrainian National Committee at the International Chamber of Commerce reveals the sentiment among investors with experience in Ukraine and Eastern Europe – almost universal disappointment with the Government's efforts to improve the business environment. At the same time, however, these respondents said they would maintain or increase their investments in Ukraine. During the World Economic Forum in June 2005, President Yushchenko adamantly stated Ukraine’s intention to provide a receptive environment for foreign investment. Overall, despite the optimism and seeming good-will created by the Orange Revolution, it would be difficult to conclude that the new government has worked in a manner yielding evident improvements for business in Ukraine’s investment climate. Factionalism and competing interests within the government of Yulia Tymoshenko, as well as a divided parliament has inhibited the promulgation of much needed legislation deemed necessary for the development of business. For the most part, the lack of progress with legal – as well as administrative - reforms has not been well received by investors. Ukraine’s success with FDI during the year has predominantly been the result of several overly significant investments by some of the world’s largest multinationals, who possess the necessary resources to operate in the most challenging of business environments should they sense a concrete possibility of an attractive return on their investments. Discussions with the investor community and further research continues to show that the enabling environment for the mainstream investor in Ukraine, as well as the small and medium size enterprise (SME) sector, remains as challenging if not tougher than in the remainder of the CIS countries. Certainly, the new government of Prime Minister
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Yuriy Yekhanurov will have to work diligently and seek to find an effective balance between competing political factions in the run up to the March 2006 parliamentary elections if it is to facilitate the realization of investor expectations created by the Orange Revolution. Some of the Yekhanurov government’s immediate policy priorities, as seen by analysts and representatives of the investor community subsequently, include: Taking a clearer position on the re-privatizations and stating the government’s intentions in unequivocal language; draft legislation Pushing through the parliament seeking to cancel hundreds of regulations that stifle the smooth flow of business and investment Promulgating the remaining legislation that Ukraine needs to pass in order to succeed in its bid to enter the WTO; The budget for 2006 must take into account the high levels of government expenditure of the 2005 budget whilst certain tax cuts need to be introduced.
UKRAINE’S PLACE IN THE WORLD Voting for a ‘European Ukraine’, as opposed to a Ukraine continuing to live in Russia’s shadow, was one of the most appealing factors for the countless thousands of supporters of the Orange Revolution. Whilst few Ukrainians would have expected their country to enter the European Union at any time in the foreseeable future as a result of Viktor Yushchenko’s Viktory in the presidential elections, his Viktory gave hope to the countless thousands who believed that a new
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Ukraine could now possibly emerge: a country embracing European political and institutional values, gradually moving away from Soviet-style brands of quasi-authoritarianism and economic centralism. Indeed, as has become evident right from the outset of the Yushchenko presidency, the conduct of his government’s with Western governments and institutions has improved significantly compared to the previous regime. Ukraine’s new president has stated that eventual EU membership is amongst his top priorities and his administration appears to have become far more committed to closer Western integration than that of his predecessor. However, the key issue for Ukraine’s government in promoting its European policy will be to do so in a manner that does not harm the country’s mainstream, deeply rooted relations with Russia. The two states, being part of the same country just 15 years ago, remain inextricably tied to one another in political, social, economic and military terms and any concerted attempts to disassemble such ties is potentially far more harmful than advantageous for both countries. Furthermore, Ukraine belongs to certain CIS regional economic organizations such as the Common Economic Space (CES), together with Russia, Belarus and Kazakhstan. Russia hopes to further develop CES with Ukraine’s further commitment to the alliance. Such ties could cause difficulties for Ukraine’s efforts to move close to European institutions, since it would make it harder for Ukraine to harmonize its laws and regulations with those of the EU with the eventual hope of entering that body. From this perspective, therefore, it is not surprising that President Yushchenko has stated on several occasions during the year that Ukraine will adhere its commitments to the CES, but as long as such commitments do not jeopar-
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dize Ukraine’s efforts to move closer to the EU and the WTO.
Ukraine and the EU As a result of an exchange of diplomatic cordialities and political good-will between Kyiv and European and North American capitals following the Orange Revolution and Ukraine’s political definition as a European (as opposed to a Eurasian or post-Soviet) state became more clearly pronounced. However, while Kyiv’s new political elite have stated that Ukraine has set itself the goal of starting negotiations on associate membership in 2007, no significant change in EU-Ukrainian relations has been taking place in 2005. The EU has set the framework for developing the relationship between itself and Ukraine on the basis of an Action Plan it had already negotiated during the Kuchma presidency, which calls on Ukraine to implement a wide ranging series of internal reforms aimed at bringing Ukraine institutionally closer to the EU. Although Ukraine’s new government signed an agreement signalling its acceptance of the general direction set out under the Action Plan, as reported in a recent study on the Enlarged EU and Ukraine by the Stefan Batory Foundation (in Poland), Brussels gave President Yushchenko’s government a ‘take-it-or-leave-it’ option with no immediate scope for renegotiation on the EU’s position over the main clauses of the Plan. Furthermore, given the vast institutional gulf presently existing between Ukraine and the mainstream EU states, there are many sceptics amongst the latter in relation to Ukraine’s EU aspirations. The sentiment amongst the EU’s Ukrsceptics seems to be that relations between Ukraine and the EU should be developed on the basis of the European Neighbourhood Policy,
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which offers the country no prospect of future membership. Either way, if Ukraine is to move closer down the institutional path of becoming a European state, rapid implementation of the Action Plan, under the direction of the Vice Prime Minister responsible for European Integration, is necessary. It is vital for the current government not too repeat the approach of the Kuchma government, that is, to make pro-European declarations without implementing any genuine reforms to make Ukraine ‘EU compatible’. Ukraine and the EU are due to conduct a first review of the implementation of the Action Plan in early 2006. Given the political crisis that engulfed the country in September and the majority of Kyiv’s political elites’ contemplation of the March 2006 parliamentary elections, it is unlikely that the first review of the Action Plan will move Ukraine any closer to Europe (institutionally) than its current position. Eventually, however, if Ukraine does make noticeable progress in pursuing democratic and market oriented reform successfully, it is likely that the EU will offer the country at least a vaguely worded long-term prospect of significantly closer relations and maybe even the hope of eventual membership. However, we should note that notable progress was achieved within the context of Ukraine-EU relations at the start of December (2005), when Brussels said that it would accord Ukraine the status of a market economy. The move to recognize Ukraine as a market economy reflects further acknowledgement of Ukraine’s reform program and is expected to enhance Ukrainian trade relations with the 25 nation EU bloc. In particular, recognising the country as a market economy will help Ukraine’s steel producers gain access to European markets without being subject to antidumping measures and thereby also
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assist foreign investors operating in the Ukrainian steel industry.
Ukraine and the WTO Ukraine’s efforts to become a member of the WTO have maintained a steady course after the Orange Revolution and by July 2005 the country had signed 37 out of 50 WTO country bilateral protocols. Before its summer recess, the Ukrainian parliament had passed 8 of the 14 trade-related bills, including the key measure of intellectual property rights which could pave the way for a bilateral trade agreement with the United States. While some socialist members of the parliament seem to oppose Ukraine joining the WTO and other international organizations, overall, the country has been making good progress towards WTO membership during the year and it would not be unrealistic to expect Ukraine to become a member of the WTO by 2006, as the following comments from the BISNIS service of the US Department of Commerce suggest: In order to achieve Ukraine’s goal of accession to the WTO, and ultimately EU membership, a number of reforms need to be implemented. Many of those reforms require Ukraine to bring existing economic legislation (tax laws, customs laws, intellectual property laws) into conformity with WTO and EU standards. Some progress in this direction was made in July 2005 with the passage of legislation addressing piracy and other legal obstacles to accession. Of the six laws passed in July, the most significant was one that strengthens intellectual property rights. Other key laws pushed through parliament ease restrictions on used car imports, stiffen environmental standards, lift requirements that half of components used by Ukrainian car manufacturers be domestically sourced, and pave the way for foreign auditors and life-insurers to operate in Ukraine. Three other new laws, including one that will permit foreign
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banks to operate in Ukraine, are being voted on in September. The passage of new legislation addressing piracy and other issues, removal of SEZs, and re-privatization of Kryvorizhstal indicate that President Yushchenko is making progress toward WTO and EU compliance, as well as cracking down on corruption. The slow pace of approval of economic reform legislation has largely stemmed from the reluctance of the Parliament's socialist faction, whose members reportedly oppose joining WTO and other supranational organizations. However, Most expect that Ukraine will become a member of the WTO within the next year.
THE ENSUING REPORT In the following sections of this report, the reader will benefit from the opinions of economic and political analysts, legal specialists and the foreign investor community on Ukraine’s business and investment environment in the year following the Orange Revolution. The report is designed to be an analytical and updated companion to Doing Business with Ukraine (3rd edition), published in December 2004 by GMB Publishing Ltd. Doing Business with Ukraine is a comprehensive resource with contributions from more than 20 companies and individuals who have first-hand expertise in Ukraine and provide in-depth analysis pertaining to Ukrainian business legislation, the political system, economy, investment climate, taxation regulations, sectoral analysis and regional overview. As a follow up to the mainstream Doing Business with Ukraine publication, the current
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report is intended to bring international investors up-to-date with the major developments in Ukrainian politics, economics and investment a year after the Orange Revolution, and examine the level of change in commercial legislation impacting on investor strategies. It is designed to be read both independently, as well as tandem with Doing Business with Ukraine . Raiffeisenbank Ukraine provides an initial introduction to Ukraine’s present political and economic environment, demonstrating the many challenges the country continues to face despite the positive international image resulting from the Orange Revolution. The law firm of Sayenko Kharenko presents a detailed legal discussion, focusing on the major amendments which have taken place in Ukrainian business (and other relevant) legislation during 2005. The report then presents European Business Association’s recommendations to the foreign investor community in Ukraine to further improve the business climate in the country, seeking to build on the initial optimism which many investors experienced as a result of the change of government in Kiev at the start of 2005. The Institute for Reforms, a Kiev-based think tank, offers an outlook and ratings for investment opportunities in Ukraine’s regions; and Dragon Capital highlights the pros and cons of doing business in the new Ukraine based on their experience and which mirrors the perspective of many companies which are themselves engaged in the process of doing business.
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2. THE POLITICAL AND ECONOMIC ENVIRONMENT IN UKRAINE Yevgen Zinovyev, Macroeconomics and Industries Expert Raiffeisen Bank Ukraine
THE POLITICAL ENVIRONMENT
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ith the benefit of confidence, guaranteed by the ‘Orange Revolution’, the team of Viktor Yushchenko had to use this chance to launch a series of democratic reforms. Confrontations among members of the team and business and political lobbying were the main impediments to launching reforms and achieving political and economic stability in the country. The populist policy of increasing social payments and unfavourable external factors triggered two-digit inflation in the
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first half of 2005. Non-market instruments of dealing with the problems received a negative feedback from business and society. The policy of controlling inflation led to financial instability and significant slowdown in economic growth (in January - August 2005, GDP growth amounted to only 2.8 percent yoy). The popularity of Viktor Yushchenko has been declining gradually: according to a recent poll (September 2005) 68 per cent of Ukrainians fully or partially supports the president compared with 73 per cent in June. The percentage of people not supporting the president increased from 21 per cent in June to 26 per cent in September. This tendency is
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explained by the fact that the government deceived the expectations formed after the ‘Orange Revolution’. The government of Yulia Tymoshenko discredited itself by launching re-privatization in favour of some business groups. In this situation the only decision that the president could take was to dismiss the government. It was difficult decision, because Viktor Yushchenko had to choose between the possibility of reanimating the situation in the country against the risk of creating a serious new opponent in Julia Tymoshenko in the upcoming parliamentary elections. In September the Verkhovna Rada endorsed Yuriy Yekhanurov as Prime Minister at the second attempt with 289 votes (he needed at least 226 votes to be appointed). This support is the result of an agreement between Viktor Yushchenko and Viktor Yanukovych, his main rival in the last presidential elections (all 50 members of the Ukraine’s Regions Party headed by Viktor Yanukovych voted for Yekhanurov). This agreement took shape in a memorandum guaranteeing honest and clear elections and cessation of political repressions and re-privatization. The President also agreed with constitutional reform limiting Presidential powers effective from January 1, 2006.
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The new government is supposed to be fully qualified technically (the main criterion for appointing new ministers will be their professional qualities, but not their political orientation) and rather free of influence from any business groups or political parties. Yuriy Yekhanurov was the optimal candidate for everybody. As a representative of the Eastern region he could balance the situation and eliminate the gap between Eastern and Western parts of Ukraine. Yekhanurov is loyal to the president and had already worked with Viktor Yushchenko. He is supposed to stop re-privatization and reanimate democratic reforms. The optimism of European and American analysts about the new Prime Minister will certainly accelerate Ukraine’s joining the WTO. The Russian establishment preference for Yuriy Yekhanurov over Yulia Tymoshenko will help to reanimate relations with Russia and stop the ‘gas war’ between Russia and Ukraine.
THE ECONOMIC ENVIRONMENT Political instability and an unfavorable external environment negatively affected the macroeconomic situation
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in Ukraine: the pace of growth of real GDP in January – August declined to 2.8 per cent compared with the same period of 2004, while the growth rate of industrial production in January – August amounted to3.5 per cent compared with the same period of 2004. The major reasons for slowdown in growth are the falling off in investments and the unfavourable external situation on the metal and oil markets. of the decline in investment activity may be explained by the following factors: fear of re-privatization caused the owners of privatized enterprises to postpone capital investments; growing political risks at the end of 2004 and the beginning of 2005 caused foreign investors to postpone investments in Ukraine; government investments declined as a result of increasing social expenditures; increased tax pressure caused a decline in the disposal income of enterprises, and, as a result, a decline in investments Taking into account the export orientation of Ukraine’s economy, the
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development of Ukraine’s major industries is driven by global economic conditions: high demand for metallurgical products in 2004 stimulated development of the Ukrainian metallurgical sector (exports account for 75% of metallurgy output), while falling demand in 2005 caused a slowdown in the metallurgical sector and, as a result, the slow down of economic growth in Ukraine. One more unfavorable external factor is the conversion of China into a net exporter of metal products that led automatically to a 76 per cent decline in the exports of Ukraine’s metal products to China in the first half of 2005 compared with the same period of 2004. In 2005 agriculture remains a significant positive contributor towards GDP growth. The expected grain harvest is 41 million tons (the same as in 2004), while the harvest of sunflower seeds is projected as 3.5 million tons (10 per cent higher than in 2004). In the first half of 2005 imports grew by 26 per cent, while exports grew only 9.1 per cent. The high growth rate of imports is explained by the following factors: the rising costs of Russian oil due to high international prices and increased duties by Russia;
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oil crises in May which caused increased imports of oil; introduction of the programme ‘stop the smuggling’ that increased official imports. The result of this tendency was a sharp decline in the trade balance to USD 1.94 billion, which is more than a two-fold decline compared with USD 3.99 billion for the same period of 2004. The commodity balance has been negative for five months with the lowest value in June (USD ï413.2 million). The government of Yulia Tymoshenko declared inflation targeting as its main strategic goal. Instruments, chosen for achieving this goal, were
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the revaluation of hryvna revaluation and loose monetary policy. This strategy of controlling inflation was highly criticized by economists, because the source of inflation in Ukraine is an expansionary fiscal policy: increased social payments lead to increase of prices, because of the inability of Ukrainian enterprises to increase output in the short-term. Loose monetary policy does not fully compensate for an expansionary fiscal policy, but it causes the liquidity of the banking system to deteriorate. As a result, Ukrainian banks began to increase interest rates and limit credit activity to decrease the demand for credit facilities.
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3. UKRAINIAN LAWS: RECENT DEVELOPMENTS Vladimir Sayenko and Partners, Kyiv
INTRODUCTION
T
he Presidential elections of 2004 marked a revolutionary change in the mentality of Ukrainian people who realized that their will and their vote can actually change the country. The change of Government has had a positive impact on the attitude of state authorities to businesses. Many burdensome administrative acts were abolished at the initiative of the new President. Some of the unreasonable legal requirements were interpreted more liberally by the administrative bodies and state courts. The registration of new businesses was simplified by the introduction of the ‘one-window’ registration procedure. The Ukrainian Parliament also contributed towards the development of the new legal system by adopting the Code of Administrative Justice, the law on Private International Law, the amended VAT law, etc. Certain laws were amended to remove restrictions on financial services provided by foreign companies, which was one of the requirements for Ukraine's accession to the WTO. Although not all of the changes can be characterized as unambiguously positive and non-controversial, they can be viewed as a step forward towards the establishment of
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the rule of law and the development of the legal and democratic state. At the same time, these legislative changes do not reflect the expectations of the business community for major changes which are long awaited. Despite all the promises, the Business Code of Ukraine was not abolished, or even amended to remove the inconsistencies with the Civil Code of Ukraine. A lot of important legislative acts have not been adopted, as expected. These include the draft laws on Joint Stock Companies, on Securities and Stock Market, on Currency Regulation, on Real Estate Tax, the Tax Code and many other legislative acts that could improve the business climate in Ukraine. The explanation for this passiveness by Members of Parliament can be explained by the distribution of political forces in the Ukrainian Parliament. After the election of President Yushchenko, many of his allies obtained senior positions in the Government and had to give up their seats in the Parliament. Even though many of the remaining Members of the Parliament are no longer in a strong opposition to the democratic forces supporting the new President, many initiatives of the Government do not receive support from Parliament. In view of the forthcoming Parliamentary elections the development of
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commercial legislation does not appear to be a priority for Ukrainian politicians in view of the coming Parliamentary elections.
ANTITRUST/COMPETITION LAW The Anti-monopoly Committee of Ukraine (the ‘AMC’), which is a state body with special status created to supervize compliance with Ukrainian competition laws, continues to increase its powers. On May 31, 2005, the Parliament of Ukraine adopted the Law ‘On Amending Certain Legislative Acts of Ukraine Regarding Strengthening the Legal Protection of Economic Competition’ (the ‘Competition Law Amendments’), broadened the powers of the AMC to control concentrations and combat concerted practices.
Expanded definition of anticompetitive concerted practices The Competition Law Amendments expanded the definition of anticompetitive concerted practices to cover actions, which led or may lead to prevention, elimination, or restriction of competition, provided that market analysis performed by the AMC demonstrates absence of objective reasons for such actions. In other words, the AMC received a legitimate possibility to define the anti-competitive concerted practices and impose fines for such practices on the basis of pure price monitoring without direct evidence, as was previously required. Effectively, this allows the AMC to impose a fine on two undertakings that increased their prices at the same time and failed to persuade the AMC that the reasons for such increase were objective. Combined with the quasi-
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judicial functions of the AMC to consider cases, adopt binding decisions, and impose fines, the AMC now has a very powerful weapon and it is not yet clear whether it will be used properly. This legislative change can be viewed as an urgent response to the sudden increases of petrol prices in Ukraine that occurred in spring 2005. At that time the government accused a number of large oil companies of fixing petrol prices, but the AMC could not collect the necessary evidence and react quickly to this problem.
Increased scope of concentrations requiring clearance from the AMC The Competition Law Amendments introduced another criterion for concentrations requiring clearance from the AMC. Previously, such clearance was required only if the asset value or sales turnover of the parties to the concentration exceeded certain thresholds. Now AMC’s clearance is also required for any concentration irrespective of the asset value or sales turnover of the parties to the concentration, if the market share of any of the parties to the concentration or the combined market share of the parties to the concentration (including related entities) exceeds 35 per cent on any goods market and the concentration takes place on this or on adjacent goods market.
Expanded list of related entities The broad notion of related entities (‘persons connected by a control relationship’ – to use the exact language of the law) has been expanded further to clearly cover close relatives of an individual: husband and wife, parents and their children, brothers and/or sisters. This will allow competition laws to combat the common practices
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of certain businessmen who used their relatives to avoid competition law requirements and at the same time to maintain an actual control over their businesses.
Simplified procedure for the calculation of fines Most fines for violation of Ukrainian competition laws are calculated as a percentage of the violator’s gross income. For example, failure to obtain clearance for a concentration may lead to a fine of up to 5 percent of the gross income. If the amount of the gross income is not known, then the AMC should, under the applicable laws, impose a fixed fine of up to 170,000 Ukrainian hryvnias (currently approx. EUR 27,000) for each such violation. Very often the AMC could not get the undertakings to provide this information and had to use the fixed fine, even if the information on the gross income was actually available publicly from other sources. The Competition Law Amendments now allow the AMC to determine the revenue of the undertaking on the basis of the so-called ‘administrative information’, i.e. the official documented information which is collected, used, and kept by state bodies, for example the state tax authorities or the State Commission on Securities and Stock Exchange (the ‘Securities Commission’). Under the applicable laws, these state bodies are obliged to provide the AMC with such information at its request.
Confidential treatment of tippees As a result of the Competition Law Amendments, the AMC gained the legal authority to keep confidential the information regarding an un-
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dertaking that was engaged jointly with other undertakings in anticompetitive concerted practices and was the first to notify the AMC of such action (the‘tippee’). Special confidential treatment can now be granted by the AMC at the request of the tippee. Together with the previously existing rule permitting the AMC to relieve a tippee from liability for anticompetitive concerted practices, this procedure allows the AMC to be more effective in investigating concerted practices. Exemptions from the filing requirement clarified Ukrainian competition laws contain an exemption from general filing requirement for concentrations involving securities brokers and other intermediaries. Instead of the usual prior approval from the AMC, such transactions only need to be notified after the closing. Recently, the AMC, jointly with the Securities Commission, adopted the recommendations in which this exemption was clarified. Thus, no prior approval is required for concentrations where the acquirer is an undertaking primarily engaged in financial transactions or transactions with securities and the shares purchased in a concentration are resold within one year. In order to benefit from the exemption, the acquirer cannot participate in the management of the target undertaking during this period. In its recommendations, the AMC provided the order for notification of such transaction, the criteria for determining whether the acquirer's primary activities fall within the stated exemption for financial or securities transactions and some guidelines on the level of participation in the management of the target that would not be permitted.
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LAW Ukrainian corporate law did not undergo any major changes in 2005. Revolutionary changes in corporate laws occurred about two years ago, when the Civil Code of Ukraine and the Commercial Code of Ukraine were adopted. Both Codes entered into force on January 1, 2004 and it was obvious that they both required a lot of work. In fact, the Commercial Code was often characterized by practitioners as an impediment to the development of a market-oriented Ukrainian legal system. In 2005 some representatives of the new government declared their intension to abolish the Commercial Code, while moving some of the useful concepts from the Commercial Code into the Civil Code. This intention has not yet been implemented. The most noticeable event in 2005 was the introduction of the ‘one window’ or ‘one-stop’ registration of companies. At the same time, the role of the courts and administrative agencies in providing guidelines on important issues arising out of application of corporate laws has increased.
Improved Procedure for the State Registration of Companies In July 2005 the ‘one window’ registration of companies finally began to operate in Ukraine. This simplified procedure was introduced by the Law of Ukraine ‘On the State Registration of Legal Entities and Individual Entrepreneurs’, effective from July 1, 2004, which it took the government about a year to implement it. The ‘one window’ registration means that after submission of one set of documents to the state registrar the company will be registered not only at the United State Register of Legal
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Entities and Individual Entrepreneurs, but also with a number of other state authorities required by law: the State Tax Administration; the State Pension Fund; the Social Security Fund for the Temporarily Disabled; the Social Security Fund for Employment-Related Accidents and Professional Diseases and the Social Security Fund for Unemployment. In the past, the newly registered company had to apply directly to each of the listed authorities according to separate bureaucratic rules and practices established by each authority, which hampered the start of a business in Ukraine. Now the state registrars transfer necessary data to these authorities and the company receives documents confirming the registrations with each of these authorities together the company’s State Registration Certificate or shortly afterwards. The whole process should take three business days, but sometimes can take about a week. The ‘one window’ registration is also supposed to cover registration at the state statistics authority, but this requirement has not yet been implemented. Some additional steps, like obtaining a permission to produce a corporate seal, are still required after registration and before the company can open a bank account or enter into a contract.
Simplified Registration of the Company’s Location The location (address) of a company or another legal entity is an important element of the corporate status in Ukraine. Most registrations and filings must be made by the company
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in the administrative district where it is located. A company that is not actually located at the address where it is registered may be liquidated by a court order at the request of governmental authorities. In the past, many companies could not register their change of location in a timely manner, because such change also required a change in the charter of the company that could not be made promptly (for example, because the law requires a 45-days advance notice for any meeting of the shareholders of a joint-stock company that is authorized to amend the charter, or because changes to the charter could not be adopted due to the absence of a quorum). Some of these problems were resolved by the Law of Ukraine No. 2452-IV of 3 March 2005, which: (1) introduced a clear definition of
the location of a company: ‘the location of a legal entity is the location of the body or person that is authorized to act on its behalf pursuant to the foundation documents of the legal entity or by law’; (2) simplified the procedure for registration of a change of location in the Unified State Register by removing the requirement for submission of amended foundation documents; and (3) removed the requirement to state the location of the company in its foundation documents from many legislative acts. At the same time, Article 4 of the Law of Ukraine ‘On Business Companies’ has not been amended and continues to require that the formation documents of a company should contain information on its location. Most practitioners agree that this requirement should be complied with until the inconsistency is resolved.
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Clarified Procedure for Signing Formation Documents In 2005, the State Committee of Ukraine on the Issues of Regulatory Policy and Entrepreneurship has issued a number of letters clarifying the procedure for the signing of changes to the charter of the company. For example, for a joint stock company changes to the charter may be signed by the chairman of the general meeting of shareholders that approved such changes. Previously, certain state registrars insisted on having the signature of each shareholder of a company on the amended charter. This created a problem if a minority shareholder refused to sign the amended charter properly approved by the majority of shareholders in accordance with all applicable procedures. Even though clarifications of the State Committee of Ukraine on the Issues of Regulatory Policy and Entrepreneurship are not legal acts, they are usually followed by state registrars.
Clarified Procedure for the Disposal of Shares in a Closed Joint Stock Company For a number of years Ukrainian lawyers debated the right of shareholders to dispose of their shares in a closed joint stock company irrespective of the limitations contained in the company's charter. The court practice on this issue was inconsistent. In May 2005, the Constitutional Court of Ukraine made a definitive ruling stating that the charter of a closed joint stock company may provide for priority rights of other shareholders and such rights must be observed. More importantly, the Constitutional Court of Ukraine observed
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that the right of shareholders to sell their shares is not absolute. This marks an end to a lengthy theoretical discussion that was echoed in a number of other areas of law.
New Guidelines from the Supreme Court of Ukraine At the very end of 2004, the Supreme Court of Ukraine issued detailed guidelines on the application of the Law of Ukraine ‘On Business Companies’ (the ‘Guidelines’). The Guidelines deal primarily with issues that arise out of the operation of joint stock companies and resolve a lot of ambiguities in Ukrainian corporate law. In particular, the Supreme Court of Ukraine has confirmed the following: The charter of a joint stock company may be declared invalid by a court, and the state registration of the company may be cancelled, if the charter does not contain all the mandatory information prescribed by law. The shareholders of the company, as well as to other persons, including state bodies have the right to challenge decisions of the general meetings of shareholders and other corporate bodies, if the rights of such persons are violated by these decisions. A court order (injunction) prohibiting a conduct of the general meeting of shareholders amounts to interference in the business activity of the joint stock company and may result in violation of the rights of other shareholders to manage the company. By law, the decisions belonging to the exclusive authority of a general meeting of shareholders
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may not be delegated to other bodies of the company, irrespective of the provisions of the company’s charter. A violation of the procedure for convening the general meeting of shareholders, including the prior notice requirement, is one of the grounds for declaring invalid the decisions adopted at such a meeting. At the same time, the decision of the general meeting of shareholders should not be declared invalid if the shareholder who was not properly notified is present at the meeting. The employment agreement concluded between a company and its CEO cannot limit the authority of the CEO provided by the company’s charter. The supervisory board of a joint stock company may consist only of the company's shareholders. A legal entity elected into the supervisory board may participate in this corporate body through its authorized representative.
FINANCIAL SERVICES In 2005 accession to the WTO became a priority goal of Ukrainian economic and foreign policy. As one of its WTO accession efforts Ukraine has undertaken to liberalize its financial services market. In particular, the set of draft laws submitted to the Parliament of Ukraine (Verkhovna Rada) included amendments to the current laws that were supposed to ensure free access of non-residents to such discriminative areas as banking, insurance and audit services. However, due to strong opposition from local financial institutions, only two of the laws have been passed by the Parliament so far.
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Abolition of Ukrainian citizenship requirement for auditors On 6 July 2005 the Law “On Audit Activities” and the Business Code of Ukraine were amended to allow foreign individuals to render audit services subject to the receipt by them of a Ukrainian certificate confirming their qualifications.
Abolition of restrictions for branches of foreign insurance companies On 7 July 2005 the Law ‘On Insurance’ was amended to allow foreign insurance companies operate in Ukraine through their branches, to take effect in five years after Ukraine accedes to the WTO. In order to set up a branch in Ukraine an insurance company shall be registered in a country that meets certain criteria (cooperates with FATF; has an information exchange memorandum signed with the competent authority in Ukraine; exercises state supervision over insurance services; has concluded a double taxation treaty with Ukraine; is not considered an offshore territory; has authorized Ukrainian insurance companies to open their branches in its territory). Moreover, the foreign insurance company shall place a guarantee deposit equivalent to the amount of its authorized capital with a solvent bank in Ukraine; shall grant an irrevocable undertaking in writing to comply unconditionally with any claims arising out of its activity in Ukraine, and its financial stability rating shall meet the requirements set by the competent authority in Ukraine. Branches of foreign insurance companies shall also keep their reserves in Ukraine. If any insurance claims arising in Ukraine cannot be satisfied with the assets of the branch and its guarantee deposit,
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these claims shall be satisfied by the parent company.
Abolition of restrictions for branches of foreign banks expected soon While the Law ‘On Insurance’ was amended (although with delayed effect), the amendments to the Law ‘On Banks and Banking’ providing for the access of branches of foreign banks to the Ukrainian market on terms similar to those for insurance companies, were overturned by the Parliament. However, given the importance of WTO accession for Ukraine and pressure on the part of the President, it is expected that after certain redrafting this amendment will still be passed by Parliament, subject to a delayed date for coming into force.
INTELLECTUAL PROPERTY Liability for IP laws has tightened significantly In order to comply with requirements for WTO accession, the Ukrainian Parliament adopted the Law ‘On Amendments to Certain Laws of Ukraine (Regarding the Restructuring of Operations Related to Manufacture, Exports and Imports of Disks for Laser Reading Systems, Equipment and Raw Materials for Their Production)’ of 6 July 2005, No. 2734IV, which enhanced the protection for copyrightable products distributed on optical media, restructured the control mechanism over the production and sale of laser discs (CDs and DVDs) and imposed additional penalties for violation of the existing requirements. The main state bodies in charge of implementing state policy in this area are the State Department of
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Intellectual Property, the Ministry of Economy, customs and other authorities. Their major weapon against copyright infringers is an inspection, a scheduled or unscheduled visit of state authorities to verify compliance with applicable laws. Scheduled inspections are undertaken not more than once per year. The period for advance notice to the company about a scheduled inspection was reduced from ten days to five days. Unscheduled raids are performed without any advance notice. Representatives of copyright and neighbouring rights holders may now assist at inspections. If a license for manufacturing, importation and exportation of laser disks is revoked, following at least two subsequent registered violations of license terms, the company may obtain a new license not earlier than 5 years after the revocation (this represents a significant increase from the previously stipulated term of one year). Furthermore, if the cost of illegally produced laser disks, equipment and/or raw materials reaches the threshold of UAH 2,620 (approximately US $520), the infringer will be subject to criminal liability. If the cost of illegal goods exceeds UAH 13,100 (approximately US $2,590), the infringer may serve a term of up to five years in prison. It is worth noting that previously the threshold for criminal liability was UAH 393,000 (approximately US $77,820). Following the adoption of this Law, the US have lifted their sanctions imposed on $75 million worth of Ukrainian exports to the US in January 2002 for the failure of the Government of Ukraine to enact and implement adequate optical disc media licensing legislation. As a further step, the US are conducting a Special 301 Out-of-Cycle Review to focus on Ukraine’s intellectual property rights enforcement and consider Ukraine’s status as a Priority Foreign Country.
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Procedure for acknowledgement of well-known trademarks has been put in place Implementing the Paris Convention of 20 March 1883 for the Protection of Industrial Property, Ukraine has developed procedures for the recognition of well-known trademarks, which may be used to defend against unfair competitors in Ukraine. For this purpose, on 15 April 2005 the Ministry of Education and Science of Ukraine adopted the ‘Regulation on the Acknowledgement of Trademark as Well-Known in Ukraine by the Chamber of Appeals of the State Department of Intellectual Property’, No. 228. Applications for acknowledgement of well-known trademarks shall be considered by the Chamber of Appeals based on the trademark’s fame in a certain consumer sector, geographical area, its value, promotion and acknowledgement etc.
The Ukrainian Parliament has attempted to introduce a law on the transfer of technologies On 6 September 2005 the Parliament of Ukraine approved the draft Law ‘On the State Regulation of Activities in the Sphere of Transfer of Technologies’ (the ‘Technologies Law’) aimed at creating a favorable environment for the development of commercial science in Ukraine. The draft Technologies Law purported to establish a monitoring mechanism over the import of technologies to Ukraine under certain state-financed contracts, provided for a fair remuneration to the creators of technologies based on the income derived from using their inventions and
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introduced certain measures protecting Ukrainian science. However, the protective provisions of the Technologies Law, namely the rule that the transfer of technologies into Ukraine may not obstruct the use of concurrent Ukrainian inventions, and the contemplated funding of the transfer of technologies by the State through limited tax relief, were attacked by the President of Ukraine as falling short of WTO requirements and, hence, jeopardizing Ukraine’s accession to this organization. For these reasons, the President refused to sign the Technologies Law and sent it back to the Parliament for reconsideration.
PRIVATE INTERNATIONAL LAW One of the most significant 2005 developments in Ukrainian law is the adoption of the Act ‘On Private International Law (Conflict of Laws)’ (CLA) on 23 June 2005.1 Initially conceived as a part of the new Civil Code (adopted in 2003), the conflict of laws element mysteriously disappeared from the draft code during the prolonged parliamentary debate. As a result, for more than a year, since the Civil Code came into effect, Ukraine lived with little conflict of laws regulation. The relevant rules outlined in the old (Soviet) Civil Code were lost when it was replaced with the new code. The CLA brings long awaited order to the area of law vital to the development of international social and economic contacts of Ukraine and its residents. It effectively ends the Soviet regulation aimed at limiting any crossborder contacts and, consequently, any use of foreign law. Instead, the new law clearly follows the guide1
The act came into effect on 1 September 2005.
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lines set by international practice, in particular the Convention on the Law Applicable to Contracts for the International Sale of Goods (the Hague, 1986) and the EC Convention on the Law Applicable to Contractual Obligations (Rome, 1980). Providing a comprehensive list of the conflict of laws rules, the CLA covers various issues, inter alia, legal capacity of individuals and legal entities in Ukraine, employment of foreigners in Ukraine, marriage to a foreign national, and jurisdiction of Ukrainian courts over disputes with foreign companies.
Limited Application of CLA The new law applies only to a limited number of commercial transactions. These are civil law transactions involving what is termed in law a ‘foreign element’. To contain a foreign element, a transaction must have at least one of the following features: at least one of the parties to it is a foreign national, a stateless person or a foreign legal entity, e.g. a company; its object, e.g. leased property, is situated on the territory of a foreign state; or an event affecting its beginning, change or termination, e.g. destruction of the property, took place or takes place on the territory of a foreign state.
New Choice of Law for Cross-Border Contracts Under the CLA, both companies resident in Ukraine and Ukrainian citizens may elect to have their contracts with foreign companies or individuals governed by foreign law. Furthermore, the law also extended the right
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to choose the governing law to unilateral legal acts made within cross-border transactions. The choice of law must be expressed or demonstrated with certainty. By their choice, the parties can select the law applicable to the whole or a part of the contract (or a unilateral legal act). At any time prior to or after the conclusion of the contract, they may also agree to subject the contract to the law other than that which previously governed it. Any choice or variation of law made after the conclusion of the relevant contract shall apply to it as of the date when such contract was concluded. Naturally, choice of law does not come unchecked. The CLA contains a number of provisions limiting the right of the contracting parties to choose the governing law. The main limitations include the following: choice of law shall not be used to avoid the application of law prescribed by the CLA; rules of foreign law shall not be applied if their application violates the public policy of Ukraine (“ordre public”), i.e. the fundamental tenets of the law and order in Ukraine; mandatory rules of Ukrainian law or the law of another jurisdiction with a close connection to the transaction shall prevail over the law chosen by the parties, e.g. rules on real estate, bankruptcy procedures or public health; any selection or variation of the governing law shall not preju2
Another example of this limitation is the CLA provision on the governing law of powers of attorney. Thus, it is the law of the state of issue of a power of attorney that regulates its issue, term of validity, termination and legal implications of the termination.
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dice its formal validity nor limit or infringe the rights acquired by third parties prior to the date of such selection or variation; and governing law of certain types of contracts and unilateral legal acts is prescribed by the CLA and shall not be subject to choice of law, e.g. foundation agreements (articles of incorporation) of legal entities are governed by the law of the state where the company is to be established. 2 Interestingly, a Ukrainian court of law or other state agency may apply Ukrainian law to a contract governed by foreign law if it has failed to construe the provisions of the foreign law within a reasonable time. Unfortunately, the CLA does not specify the minimal period of time within which a court or a state agency must try to do so. This provision may endanger the choice of law by effectively limiting it to the law of the few jurisdictions ‘familiar’ to Ukrainian judges and civil servants, e.g. laws of the Russian Federation and Belarus. The further is the jurisdiction of the selected law from Ukraine, the higher will be the likelihood that the contracting parties will sweat hard to help the Ukrainian court understand what that law says and means.
New Rules on the Formal Validity of Contracts The CLA also modified the rules on the formal validity of contracts. Under the new law, a contract is formally valid if it satisfies the formal requirements of the governing law. Failing that, however, it will still be formally valid if it satisfies the formal requirements of either the jurisdiction where it was concluded or the jurisdiction of the offeror, if the parties reside in
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different jurisdictions. The same rules apply to the formal validity of unilateral legal acts. Despite these changes, the CLA retained the following two requirements: any cross-border contracts involving Ukrainian citizens or companies shall be executed in writing; and contracts concerning real estate shall satisfy the formal requirements of the jurisdiction where such real estate is situated.
Legal Capacity of Foreigners The CLA provides that the personal law of an individual is the law of the state of his or her citizenship. In the case of double citizenship, the law of the state with the closer connection shall apply, in particular the state of his or her residence or main activity. At the same time, it confirms, in line with the Constitution of Ukraine, that foreign nationals and stateless persons shall have the same legal capacity in Ukraine as Ukrainian citizens, unless otherwise provided by law. Personal law of a legal entity is the law of the state where it is registered or otherwise incorporated.
Right to Choose Ukrainian Courts in Cross-Border Transactions One of the major innovations of the new law concerns litigation. Contracting parties now have the right to choose Ukrainian courts for dispute resolution (subject to certain limitations, of course 3 ). Previously, no such
possibility existed for commercial disputes, i.e. disputes involving either legal entities or individual entrepreneurs. Unfortunately, the law does not go as far as permitting contracting parties to choose foreign courts for the same purpose. The CLA also repeated the previous rules which allowed Ukrainian court to hear disputes involving foreign companies, provided that such companies had either a representative office or real estate in Ukraine. This rule, however, was somewhat restated. Ukrainian courts will now be able to open procedures against foreign companies based on the presence of their movable or immovable property on the territory of Ukraine provided that such property may be used for recovery.
PRIVATIZATION LAW Basic Ukrainian privatization laws have remained relatively stable in 2005. At the same time, privatization and ‘re-privatization’ have become the hottest topics for many political debates. Various governmental officials were sending inconsistent messages to large businesses regarding the intensions of the new government to return into state ownership a large number of companies that were privatized under the old regime with substantive violations of Ukrainian law. These threats did not materialize and the only company that was successfully taken away from its owners and sold at a privatization tender was Kryvorizhstal.
Kryvorizhstal – the largest privatization in Ukrainian history
3
For example, Ukrainian courts shall have exclusive jurisdiction over disputes concerning real estate situated in Ukraine or bankruptcy of Ukrainian companies.
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Joint-Stock Company “Kryvorizhstal” is the largest carbon steel long products producer in Ukraine and the nearby region with 2004 liquid steel
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production of 7.7mn tons and 2004 shipments of 6.7mn tons. It also produced 17.1mn tons of iron-ore. In 2004 Kryvorizhstal was sold for US$800 million to a local investor in a privatization widely condemned as rigged. After a number of court decisions in summer 2005 Kryvorizhstal was returned into state ownership and then sold at an auction in October 2005 for 4.8 billion US dollars. This privatization is viewed as a major success of the new government, as the purchase price exceeds the total proceeds from all prior privatization tenders in Ukraine, despite numerous burdensome post-privatization obligations and despite all the unresolved claims from the former owner of Kryvorizhstal. One of the mechanisms that allowed Kryvorizhstal to be sold at a good price was a new auction procedure introduced by the State Property Fund of Ukraine (the ‘SPFU’).
Major changes in the privatization procedures The procedure for privatization of large state companies like Kryvorizhstal is governed by the Order of the SPFU ‘On Approval of the Regulation on Procedure for Conducting the Tenders on the Sale of Blocks of Shares of Joint Stock Companies’ of August 31, 2004. On July 11, 2005 the SPFU amended this procedure (the ‘Amended Tender Procedure’). While these amendments are general in nature, it is obvious that they were adopted specially for Kryvorizhstal privatization. The main novelty of the Amended Tender Procedure is the auction procedure contained in the new Section 8 of the Regulation. Previously, all participants of the tender submitted their offers in a sealed envelope. Now all participants of the tender submit a
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price offer in a sealed envelope before the beginning of the auction. The highest bid offered by the prospective buyer becomes the starting bid. Then all other buyers can raise the bid by a fraction of no less than 1 per cent of the initial price, which is determined by the government in the tender conditions. The auction is conducted by a professional auctioneer who accepts the bids until there is only one buyer remaining, who becomes the winner. This mechanism is called a ‘tender with the elements of an action’. It is supposed to bring equal opportunities and additional openness into the privatization process.
PROCEDURAL CODES (ADMINISTRATIVE AND CIVIL PROCESS) Ukrainian law developed rapidly after Ukraine declared its independence in 1991 to shift to a legal system that would adequately serve the purposes of a market economy. At the same time, a lot of the procedural laws were still based on the principles developed during the Soviet times and did not grant adequate protection to the rights of individuals and businesses. For example, until recently the Code of Civil Procedure adopted in 1963 was still used in Ukraine to govern all the procedures of a civil litigation and administrative proceedings in the Ukrainian courts. The new Civil Procedure Code was adopted on March 18, 2004 but its entering into force was conditional upon the adoption of the Code of Administrative Justice. After the adoption of the Code of Administrative Justice on July 6, 2005, both Codes entered into force on September 1, 2005.
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Administrative Proceedings The system of administrative justice consists of two levels of courts of first instance (local and territorial), appellate courts, High Administrative Court and the Supreme Court of Ukraine. If one of the parties is a municipal authority, administrative cases in the first instance are handled by the local courts of general jurisdiction. For any cases involving state authorities the territorial courts serve as courts of first instance. If the administrative case is brought against the local executive authorities or bodies, the appellant has the right to choose between the local and territorial court as a court of first instance. The High Administrative Court of Ukraine may also serve as a court of first instance when it considers cases concerning the cancellation of registration of a candidate in the presidential elections and cases against the Central Election Commission concerning the results of an election or referendum. The jurisdiction of administrative courts includes: challenges of the acts or decisions of state or municipal authorities by individuals or legal entities, except challenges of their constitutionality (provided that until January 1, 2007 disputes between legal entities and tax authorities remain within the jurisdiction of commercial courts); disputes regarding public service; disputes among authorities regarding their performance and competence, as well as disputes arising from administrative agreements;
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other disputes arising from the claims of the authorities in cases, provided by the laws; disputes arising from the election or referendum issues. The most important innovations of the Code of Administrative are the following: legal entities have obtained a clear right to challenge the actions or inactions of state and municipal authorities; there is a presumption of guilt on state or municipal authorities; therefore they should prove the legality of their challenged actions or inactions; the administrative court is free to request evidence, even if not requested by the appellant; full recording of the hearings (this requirement has not been completely implemented due to practical reasons).
Civil Proceedings The Civil Procedure Code introduced many novelties into civil proceedings, such as the recording of court hearings, expedited handling of undisputable claims, possibility for consideration of a case in the absence of one of the parties, contractual jurisdiction of state courts, and expedited procedure for filing an appeal. Full recording of the hearings Full recording of the court hearings is viewed as an important safeguard to ensure objective evaluation of the case by the court and prevent possible abuses by the parties or the judge. However, the implementation of this requirement has been stalled due to the lack of funding and resistance from judges and some parties to the
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proceedings. On September 23, 2005, a legislative amendment was passed, which postponed the introduction of the requirement for full recording of all court hearings until January 1, 2008. In the meantime, recording of court hearings may be invoked upon the request of one of the parties.
spondent based on the materials of the case. Although such a judgment can be challenged by the respondent by means of a petition for review of the judgment or in appellate proceedings, the new procedure should allow the delivery of justice to be expedited. Contractual jurisdiction of state courts
Expedited handling of undisputable claims The Civil Procedure Code introduces a mechanism, whereby undisputable claims duly supported by necessary documents can be considered by a court without following the general procedure for handling civil lawsuits. Such claims can be considered by a court without appointing a court hearing and a court decision can be rendered within three days after the claim is filed. The idea is to reduce the formalism of the procedure in relatively simple cases and decrease the workload of the courts. This expedited procedure is available for claims that are based on a written agreement, collection of salary claims, compensation for the search of respondent, debtor, child or transport carrier of the respondent, and certain other cases. Consideration of a case in the absence of one of the parties One of the common methods to delay the court proceedings used to be the failure of the respondent to appear for the hearing. Although eventually the judge could render a decision in a case where the respondent repeatedly failed to appear in court without any valid excuse, lack of clarity in the applicable provisions resulted in substantial delays. The Civil Procedure Code now allows the judge to render a decision in the absence of the re-
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The Civil Procedure Code introduces the contractual jurisdiction of state courts. It means that the parties can specify in writing the territorial jurisdiction in which the court will hear their case. Certain cases are subject to exclusive jurisdiction that cannot be changed contractually, such as cases regarding immovables, exclusion of the property from the distrainment, certain claims of creditors in the inheritance procedure, and claims arising from the carriage of goods, passengers, etc.) Expedited procedure for filing an appeal According to the new Civil Procedure Code, a submission of appeal consists of the submission of the petition for an appeal and the claim of appeal. Claims of appeals have to be submitted through local courts, as previously, which must transfer them to the appellate court not later than three days after the appeal period has expired. However, the local courts have no right to review and return the appeal even in cases of formal violations. The appellate courts now also have full power to evaluate all evidences in a case and render the decision based on the merits of the case. They no longer need to return of cases to the local courts in certain cases, when the decision of the local court is cancelled.
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4. MEASURES TO IMPROVE UKRAINE’S INVESTMENT CLIMATE European Business Association, Kyiv
T
he following comments and recommendations are provided for the present report from the executive summary of all short- and medium-term measures to improve the investment climate in Ukraine, as prepared by the European Business Association’s (EBA’s) Investment Climate Committee and its special Working Group and summarized on October 17th, 2005. This document presents the EBA view on the most urgent measures to be taken as soon as possible by respective governing authorities. As a member of the Foreign Investment Advisory Council of Ukraine, the EBA is ready to maintain a constructive dialogue with the President, the Government and the Verkhovna Rada of Ukraine in an effort to reach the common goal of improving the investment climate in Ukraine.
INITIAL STEP CREATION OF A PERMANENT GOVERNMENT TASK FORCE ON INVESTMENT CLIMATE. The government should reformulate its Expert Group/Task Force under the President’s Secretariat/Prime Minister, with the participation of private
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as well as government experts. This Task Force would not only review the main issues for investors (both, short term and medium term) but also define ‘how’ and ‘who’ would implement these recommendations.
PROPOSED SHORT-TERM MEASURES Clear Definition of the Objectives/ Role of the Government and Improve Public Transparency. In order to build sufficient private sector confidence to revive investments, the government will need to give stronger signals that it is addressing one of the main concerns of the private sector: i.e. that the Ukrainian Government still retains many of the characteristics of Soviet public institutions overloading the private sector with onerous and unpredictable demands and requirements, including heavy regulations and interventions in the workings of the market. In the short term, the following two measures are recommended, with more substantive reforms delegated to the medium term after the elections (see below).
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As a first initial step to reform the public sector, the President must make a clear and firm policy statement on the main objectives and role of the government. To make it more credible, this statement must be endorsed by the Prime Minister and the Chairman of the Rada. The President should state that the government will concentrate only on those activities that warrant government involvement because of their ‘public interest’. The government’s role will be based on the premise that productive and revenueearning activities will be carried out essentially by the private sector in a free and competitive market environment. As a second step in the reform of the public sector, the government should immediately increase public accountability and public scrutiny by making government information more transparent and more freely available to the public, subject to national security considerations. This can be achieved by expeditiously passing legislation on ‘Free Access to Government Information’ on any non-national security matter. Public procurement procedures should also be made more transparent. The government may also want to introduce the ‘external audit’ of public sector activities.
Enactment pending key Legislation for Business Activities. The government can give a clear message that it is taking concrete actions by pushing through Rada some key business legislation, particularly to: (i) Enact the Join Stock Companies
law – in a form that complies with OECD Corporate Governance Principles; (ii) Remove conflicts between the Civil and Commercial Codes by eliminating the Commercial
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Code and passing some of its provisions to the Civil Code – the Commercial Code retains many Soviet provisions that conflict with the Civil Code (such As the definition of ownership), creating uncertainties; and (iii) enact the legislation required to gain access to the WTO, as this access will show the commitment of the government to move towards western standards and practices. In order to improve the overall environment of business enablement, the government should continue to work on removing major regulatory barriers to starting and operating a business. In particular, the government should monitor the implementation of the law on permits (no. 2806, dd. Sept.06, 2005), and the law on entrepreneurs’ rights during inspections should be adopted and implemented.
Acceleration of Implementation of a Programme of Quick De-Regulation of Business Activities The business environment can be markedly improved by quick deregulation through the adoption by the government of a regulatory ‘guillotine’ process. The regulatory guillotine is a process to review rapidly a large number of laws and regulations, and selecting by a given ‘deadline’ a limited set of those that are of ‘public interest’. After the deadline, all other laws/regulations are invalid. The guillotine has been effective in other countries because it places the burden on the regulatory agency in Ukraine (generally answerable to a ministry) to justify which current laws/regulations should be retained, not which ones should be eliminated.
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Efforts should be continued to make the administrative procedures of the government more investor-friendly. In particular, implementation of the law on the system of business permits should be monitored, and the law on entrepreneurs’ rights during inspections should be developed by the government, adopted and implemented.
Passing Clear Signals that Property Rights will be Respected The ‘re-privatization’ programme raised uncertainties about respect of property rights. This issue should be closed as soon as possible. For future privatizations, the government should make a clear policy statement on its privatization strategy, and make the privatization programme and privatization procedures fully transparent and available to the public.
Improving the Country’s Image through Public Communications, and better Transparency The government should develop a Public Communications Plan to ensure that the private sector receives adequate and truthful information about government activities. It should set up an adequate organizational arrangement and budget to implement this plan and amend as appropriate the laws on advertising and the media. Senior government officials can increase confidence by making more periodic and regular communications with the population. Transparency in business should be improved by requiring all companies filing tax returns to prepare financial statements based on International Financial Reporting Standards (IFRS) starting on January 2007. The infrastructure support for this should be put in place immediately. This will
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help in reducing corruption and the size of the shadow economy and increasing tax revenues.
MEDIUM-TERM MEASURES TO ELIMINATE BARRIERS TO FDI After April 2006, the government could initiate more fundamental reforms that are too time-consuming and politically sensitive in the short term. In the meantime, the above-mentioned Task Force should elaborate the detailed plans for the implementation of these reforms immediately after April 2006. The following medium-term reform measures are needed to attract foreign direct investments to Ukraine:
Implementing Fundamental Public Administration Reform Public administration reform is needed to de-sovietize public institutions and ensure the successful and long-lasting implementation of administrative decisions and policy changes. Today, the inadequate government apparatus is one of the main constraints to the implementation of economic and social reforms. International experience suggests that without an adequate approach, policy changes may not be implemented and if implemented, they may be reversed soon thereafter. Based on a clear and widely accepted definition of the role of the government, public administration reform will include: (i) a re-definition of the functions of
individual government agencies; (ii) improvement in their operations and modus operandi; and (iii) modernization of its civil service.
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In fact, the objective of public administration reform should be to implement the redefined role of the government to support the private sector. To gain in efficiency and accountability, some functions could be decentralized to local administrations which may be given the possibility of raising their own budget funds. Un-necessary functions would be eliminated. Other functions could be transferred, outsourced or sub-contracted to the private sector.
Development and Implemention of Market-Oriented Fiscal and Tax Policies. To address fiscal deficit concerns in 2005, the government took a number of measures to reduce the potential fiscal gaps, including elimination of tax exemptions and privileges, increases in excise taxes, further accumulation of VAT arrears, etc. Although these measures generated additional revenues, some of them have generated uncertainties affecting the business environment negatively. Some of these measures should be corrected, such as erroneous elimination of exemptions in Free Economic Zones, or accumulation of VAT arrears. In reviewing Fiscal Policies, attention should be paid to Tax Burden for businesses, which is excessive today when compared to other neighbouring countries. The government should consider the competitiveness of tax policies with the aim of reducing the payroll tax, the profit tax, and other business taxes to more reasonable levels. Thereafter, tax policies should remain unchanged and stable for several years, as tax unpredictability is a major obstacle to investments. Tax administration should also be streamlined and more transparent.
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Despite the above measures, the remaining fiscal deficit may still be large. Over the long term, the government will need to carry out a comprehensive audit of public sector expenditures in order to make them compatible with a ‘reasonable’ level of taxation and revenues. This audit should be made within the context of the execution of public administration reform, as noted earlier.
Removal of Uncertainties in the Legal Environment and Enforcement of Business Contracts The lack of a stable and predictable legal environment increases the cost and risk of doing business in Ukraine. The government should appoint a Task Force to secure the stability and predictability of the legal environment, particularly by: (i) removing
inconsistencies among enacted laws and regulations, in areas including construction and real estate; (ii) ensuring consistency of new laws with the existing laws; (iii) defining processes and responsibilities for drafting and reviewing new laws better; and (iv) defining the required reform of the judiciary system to make it more effective and give it more autonomy and adequate financing and training.
Strengthening the Financial Sector and Monetary Policies. The NBU has to enunciate its longterm monetary policy clearly. If the monetary policy were to move towards inflation targeting, the NBU will need to develop the capacity to perform open market operations. The
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NBU should also enforce prudential regulations and supervision better. The Government should also enact the Financial Securities Reform Law and improve SEC membership. Draft legislation has already been prepared with the assistance of international advisers.
Deepening Trade Liberalization. Following Ukraine’s accession to the WTO, a Task Force should be established to prepare Ukraine to secure Free Trade Agreements (FTAs) with the European Union and other regions. The Task Force should also carry out analytical work to demonstrate the benefits for Ukraine of FTA’s and counterbalance any likely local opposition to them. Ukraine still needs to address other issues on trade policy, including cumbersome customs and inconsistent procedures for
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certifications, clearances, import/ export valuation, temporary imports, etc.
Fully Staff the Investment Promotion Agency. The government should further strengthen the Investment Promotion Agency to identify policy barriers to investments and to attract large investors as well as small and medium firms. The Agency should develop a comprehensive plan to attract large, medium sized ands small investors. This plan should include investor targeting and the reliable information needed by investors. It should also include a plan to provide financing to medium and small firms.
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5. UKRAINE’S REGIONS SINCE THE ORANGE REVOLUTION Markiyan Dacyshyn, Director Ukrainian Economic Think-Tank, ‘INSTITUTE FOR REFORMS’,
D
uring the recent decade Ukraine has drawn less than $10 billion of foreign direct investment, whereas 2004 annual FDI inflow reached a record high $2 billion, to be followed by $1.6 billion forecast for 2005. Experts suggest that 2006 might be a crucial year for Ukraine, converting it into an ‘investment haven’ rather than conserving the current ‘as-it-goes’ situation for years and losing competitiveness in the international investment market to Romania, Russia or even Belarus. Relatively poor investment inflow during the first 6 months after the Orange Revolution and contradictory Government economic policy threatens the positive scenario for Ukraine (see Figure 5.1). However, there are a number of reasons for future success. Among them is the UKRAINE brand promotion at the international level
by Ukrainian sportsmen (swimmer Yana Klochkova, soccer-player Andriy Shevchenko, boxers Volodymyr and Vitaliy Klitschko), and artists (pop-singer Ruslana, winner of the 2004 Eurovision song contest). Furthermore, the Orange Revolution generated positive expectations from the world business community. According to ‘Correspondent’ magazine, publications in the international media covering Ukraine during the Orange Revolution, which were positive and promotional, might have cost up to $10 billion, if considered as a paid for PR-campaign. There is no doubt that much will depend on Government policy under the conditions of interntional competition among in the global investment market. Despite world FDI decreasing sharply during the past 5 years, annual FDI inflow in Central and Foreign direct investment in Ukraine, USD mln 1930
2002
2000
2003
2004
Jan-June 2005
1800
1458 1600
USD mln
1400
1320 1075 980
1200
811
1000
706
800
491
473 369
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340 176
400 200 0
Inflow
Outflow
Net inflow
Figure 5.1
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Eastern Europe remains at $20–25 billion. It confirms the status of the region as one of the most attractive investment destinations. Although Ukraine is a unitary state, there is quite a contrast between the investment climates of its regions. Therefore investor allocation decision-making is not an easy task. The political preferences of the regions during the recent presidential elections might provide an interesting background. Western-oriented, liberal economist Viktor Yushchenko received strong support in Western, Central and Northern Ukraine. These regions’ economies are small and moderately business-based, including a substantial share of the agrarian sector and receiving a number of medium-sized foreign investment projects during the recent decade. On the other hand, a majority of the Eastern and Southern Ukraine population voted for the then Prime Minister Viktor Yanukovych, a supporter of the administrative style of management. It should be noted that followers of Yanukovych inhabit highly industrialized (coal-mining, non-ferrous metallurgy, ore-enrichment etc.) settlements, where a paternalistic pattern of living (modus vivendi) prevails and foreign businesses will not find the going to be easy under severe competition from the local business tycoons. Observers believe that the economic status of Yushchenko’s supporters – a so-called middle-class of society – played a substantial role in the Orange Revolution success. The latter might even be classified as a bourgeois revolution, since the economic rights of protesters would be violated had Yanukovych won the election. However, with the passage of time political tensions at a grass-root level loosen and it is not always easy to tell the difference between the regions in terms of their foreign investor perception.
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Since 2000 the Ukrainian Economic Think Tank ‘Institute for Reforms’ has been assessing regional investment attractiveness and publishing annual rating reports in order to provide up-to-date information to both business and government communities. The most recent experts’ findings are presented in this article.
REGIONAL PECULIARITIES OF DOING BUSINESS IN UKRAINE When entering the Ukrainian consumer market, it is understandable that one should start business in cities with more than 1 million population. However, the answer to the question where to locate production facilities or launch the 13th affiliate of a company is not so evident and requires detailed analysis of local peculiarities. In this regard, in order to assess the complex characteristics of the local business climate one should pay attention to the rating assessments of regions and cities of Ukraine, prepared by the Ukrainian Think Tank ‘Institute for Reforms’. The undoubted preference for the City of Kyiv, the capital of Ukraine, among investors is caused by the concentration of finance, information and human resources and market infrastructure development there, as well as the headquarters presence of almost all big companies working in Ukraine. Foreign investments drawn to Kyiv originate from the U.S.A., Cyprus, Great Britain, and Germany. This structure of FDI origin is similar to other Ukrainian oblasts. It should be noted that every third dollar of foreign investment in Ukraine was invested in Kyiv City (see Figure 5.2). One third of foreign investment is targeted at the Eastern regions - the Dnipropetrovsk, Donetsk, Zaporizhzhya, Kharkiv and Luhansk
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oblasts. These oblasts have substantial industrial potential, first of all, in metallurgy, machine building and chemistry. They are the most attractive destinations for investors originating from the U.S.A., Great Britain and Germany. Historically, these regions maintained strong trade relations with Russia due the geographical closeness, Russian-speaking population and similar mentality. However, more recently foreign economic activity has been developing with European and Asian countries. As a result the share of the CIS countries in the foreign economic activities of these oblasts diminishes every year, although it still remains substantial. It should be noted that those industrial companies are based here (namely steel mill Kryvorizhstal and others), which were sold to local business tycoons through the doubtful privatization tenders during the last months of Kuchma’s term in Presidential office before the 2004 elections. The competitive advantages of the Southern Regions of Ukraine (Odesa, Mykolaiv, Kherson oblasts and the Autonomous Republic of Crimea) are caused mainly by their access to the Black Sea and the Sea of Azov. Port cities, such as Odesa, Yuzhne and Illichivsk accumulate substantial finance resources by means of seagoing cargo transportations. The most
profitable investment targets in the region are port-based enterprises, the food industry and leisure facilities. Due to the climate and their natural resources Central Regions have considerable agriculture potential. As one may know, Ukraine has the biggest amounts of black earth soil in the world. Moreover, the regions have a receptive common market that stimulates trade development. As a result such oblasts as Kyiv and Poltava managed to draw the biggest amount of investment in Ukraine. Activities of European investors in the Western Regions of Ukraine (Lviv, Ivano- Frankivsk, Zakarpattya, Ternopil and Volyn oblasts) prove the importance of the geographical factor in foreign businesses preferences. The pro-western orientation of the Western Ukrainians also has historical roots: these territories used to be a part of the Austrian Hungarian Empire in 19–20th century and enjoyed an extremely liberal autonomous status in comparison with the Soviet regime, which pervaded the entire Ukraine during 1918-1939. It is worth noting that Lviv (1,115 projects) and Zakarpattya (609) oblasts are among the top-5 of the Ukrainian regions in terms of numbers of foreign investment projects, although their total investment volume put both regions only at the bottom of the
Foreign direct investment by region, as of July 1, 2005 Kyiv city 33%
Dnipropetrovsk region 10%
Other 21%
Odesa region 6%
Lviv region 4% Crimea 4%
Kharkiv region 5%
Donetsk region 5%
Kyiv region 6% Zaporizhzhya region 6%
Figure 5.2
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top-10 in terms of FDI ($360 and $245 million respectively). European businessmen seek to invest in the food industry, trade and wood processing of the Western regions. In the Institute of Reforms rating of Ukrainian cities, Kyiv City, Slavutych, Yuzhne and Uzhhorod enjoy a considerable lead over the rest of the municipalities. Western cities like Ivano-Frankivsk, Lviv, Lutsk, Rivne, Ternopil, and Chernivtsi have emerged as the most developed Ukrainian oblast centres. 2003 and 2004 saw the Southern coast cities of the Crimea triumph in the Ukrainian territories rating. Tourist number growth ensured high rankings for Yalta, Sudak and Alushta. Besides, territories neighboring Kyiv City and forming a kind of ‘Golden Ring’ around the capital, dominate in the upper part of the rating table. It is obvious that locals’ incomes are hardly dependent on the capital’s market. Everyday labour migration has to be mentioned as the primary factor. Rating studies revealed that the location of a territory on the border with other countries influences local economic development. The majority of territories, which border on the present or prospective members of the EU, register higher ratings than the Ukrainian average score. On the other hand, neighbours of the former Soviet republics have lower than average economic development.
INVESTMENT RATING OF THE UKRAINIAN REGIONS Traditionally, the City of Kyiv heads the investment ranking, its two-fold led over the nearest competitors being more than convincing. However, capital’s advantage is decreasing annually. The group of leaders also
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includes Kharkiv, Dnipropetrovsk, Odesa and Donetsk oblasts that have left the other regions far behind them. Interestingly, the Kharkiv, Dnipropetrovsk and Odesa oblasts which rank 2nd, 3rd and 4th respectively receive almost the same index rating, underlining the severe competition within the leader group. As compared to 2003, Donetsk oblast has risen 2 points, having made a considerable advance in the ‘Enterprising and Local Authorities’ rating (up from 17th to 6th place). Comparative investment and dynamic ratings of the Ukrainian Regions are displayed graphically in Figure 5.3. The group of ‘runners up’ consists of 6 regions, which in terms of their index ratings are balanced between the leading regions and the rest. The group is led by the Zaporizhzhya oblast with its industrial economy. Significantly, four representatives of this group together with Kyiv have entered the top-5 list of the Ukrainian regions in terms of human resources development. These regions are the Republic of Crimea, Zakarpattya, Poltava and Kyiv oblast. It should also be noted that Zakarpattya which ranks first among the agriculture-industrial regions, is the single representative of its category among the ‘runners up’. Continuing with human resources assessment the weakest are the two major coal mining regions of Donbas – Donetsk and Luhansk oblasts. Both in 2003 and in 2004 these oblasts held the last two places in the Human development category rating. Kherson and Zhytomyr oblast clearly occupy outsider places. During two consecutive years they ranked respectively 25th and 26th in the investment rating. In terms of the 2004 rating, the other outsider – Sumy oblast notably leaves these regions behind; together the three form the ‘tail’. Sumy oblast is the weakest region among those with an industrial-
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1.250 1.175
Dynamic Rating
Semiannual 2005
2004 Annual
Investment Rating
1.025 0.950
Zhytomyr
Sumy
Kherson
Ternopil
Luhansk
Chernihiv
Ivano-Frankivsk
Kirovohrad
Khmelnytsky
Rivne
Volyn
Vinnytsya
Mykolaiv
Chernivtsi
Cherkasy
Zakarpattya
Crimea
Kyiv oblast
L v iv
Poltava
Zaporizhzhya
Odesa
Donetsk
Kharkiv
Dnipropetrovsk
Kyiv City
0.080
0.280
1.100
0.480
0.680
Investment and Dynamic Ratings of the Ukrainian Regions
0.880
Ukraine
Figure 5.3 Investment and Dynamic Ratings for the Regions
agrarian economic structure, being inferior to Mykolaiv oblast with a similar economic structure and ranking the 13th in the index rating.
2005 HALF-YEAR DYNAMIC RATING OF THE REGIONS Ukrainian regions differ in terms of their economic structure and size. Both these characteristics make make it important to be accurate when comparing, for example, Donetsk and Ternopil oblasts. To provide meaningful results from its rating studies, experts of the Ukrainian Think Tank ‘Institute for Reforms’ have developed a Dynamic rating. It provides a key indexed assessment of changes in the economic development of a region during the first 6 months of 2005. Half-year 2005 growth index analysis findings are sensational. For the first time Kyiv City, which is a leader of the Investment rating, topped the Dynamic rating table. Such a high integral growth index is not conventional for a large regional economy like Kyiv City. Large-scale business
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activities at the municipal level with a volume consumer market of 3 million inhabitants makes high growth difficult to achieve. However, during January–June 2005 the capital registered the highest growth in retail trade turnover (+29 per cent), paid services (+39 per cent) and residential apartments construction (+ 160 per cent). Mykolaiv and Kirovohrad oblasts joined the group of Dynamic leaders. In particular, Kirovohrad region enjoyed an amazing increase in investment (+150 per cent) and long-terms bank loans to businesses (+37 per cent) over 18 consecutive months The highly industrial Eastern regions of Dnipropetrovsk and Donetsk have also done well in the ratings (ranking 5th and 10th respectively). While Dnipropetrovsk registered substantial increases in wages and householders’ income and exports, the Donetsk’s high rating was caused by the trend in long-term bank loans trend and retail trade turnover. Regional economies trends during the first half of 2005 reveal increased in consumer and investment expenditures. State budget funds for social
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programmes as well as average wage growth are the key drivers of the retail trade and services in 2005. Although foreign investment inflow didn’t meet the Government forecast, some regions are enjoying big investment project start-ups. The dynamic indices of the regions go some way to explain the ranking of a region in the investment ratings or its movement in the rating table during a period of time. Previous years’ experience confirms our proposition that if the dynamic indices are high over several years they may certainly generate the upward move of a region in the investment rating table. For example, the consistently high 6th place of Rivne oblast in the Dynamic rating for the last two years corresponds to an 8 points jump in its investment rating. Zakarpattya oblast, a leader of the Dynamic rating for the last two years has moved up by a step in the Investment rating and has good prospects of improving its position in the next Investment rating table.
OUTLOOK Taking into consideration the increasing costs of doing business in Kyiv City, regional investment patterns in Ukraine will modify in 2006-2007 Thus, investors will focus on regional markets looking for developed infrastructure and reasonably priced labour. The policy of local authorities and stories of successful investment stories in the territory also merit special attention.
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The concentration of investment inflows in the 13 regions, where special economic zones (SEZs) were established in 1999–2001, will also depend on a solution to the problem arising from the cancellation in March 2005 of tax exemptions, even for those SEZ-based companies who have fulfilled their investment contractual obligations (investment and jobs commitments). Government in a post-revolutionary fit of rage cut down all kinds of tax and duties privileges and exemptions, which were quite popular during Kuchma’s times and had amounted in 2004 to more than 10 per cent of the state budget. A number of foreign companies suffered from this decision. Among them are Cargill (U.S.A., $41 million invested), Yazaki-Ukraine (Japan, $32 million), MaltEurope (France, $26 million) and others. According to the draft Law recently delivered to the Parliament, such investors will be granted compensation and an extra period for the utilization of tax privileges. The challenges of Ukrainian investment policy in the post-revolutionary period are complicated by political tensions in advance of the March 2006 parliamentary elections and Constitutional reform that will come into force at the date of the new elected Parliament’s first session. However, the competitive advantages of Ukraine and its regions are strong enough to secure the concentration of most of the Central European investment inflows on the banks of the Dnipro river.
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6. DRAGON CAPITAL COMPANY CASE STUDY HISTORY
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ragon Capital (‘Dragon’) was established in April 2000 in Kyiv as an independent investment bank dedicated to helping Western portfolio and strategic investors to succeed in Ukraine. Today, it is one of the country’s largest investment houses providing the full range of brokerage and corporate finance services to foreign and domestic institutional and strategic investors both in Ukraine and the Central and Eastern European region. Dragon was founded by a group of Ukrainian and Central European market veterans, who had worked for Wood & Company, a leading investment bank in the region, and had been present in Ukraine since 1996. The three main lines of Dragon’s business include: 1) Brokerage - Dragon trades in all
major Ukrainian stocks and is increasingly active in corporate bonds; it has been the largest Ukrainian stock broker by turnover since starting uop in business in 2000; Dragon clients are institutional and retail investors mostly from Europe and the United States. 2) Investment Banking - Dragon is one of the largest corporate finance advisers in Ukraine; in addition to Ukraine, Dragon has worked on assignments in the Czech Republic, Slovakia and Romania, and has provided advisory services and completed deals for multinational clients
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such as Bongrain, Bonduelle, Dirol Cadbury, CRH, Heidelberg Cement, InBev, and RUSAL. 3) Private Equity - Since 2000, Dragon has built up a diversified private equity portfolio that includes several commercial real estate projects as well as companies in DIY retail, brewing, and agricultural machine-building.
FACTORS INFLUENCING THE DECISION TO BEGIN BUSINESS IN UKRAINE In 2000, after Viktor Yushchenko became prime minister, many local investors and businessmen genuinely hoped for a quick turnaround. It took longer than expected, but the decision to start so early, when Ukraine was shunned by foreign investors after the 1998 crisis, proved correct. Dragon Capital began in business as a brokerage, but as new opportunities emerged along with the country’s continuing economic growth it broadened its activities to encompass corporate finance, capital generation, privatization, mergers and acquisitions, financial advice and private equity. The private equity business became particularly important as Ukraine had many undervalued enterprises at that time that could be bought either through privatization or through the consolidation of
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property. Overall, Ukrainian assets were extremely cheap five years ago and, after domestic politics and the economy became more stable and predictable, more and more foreign investors started to enter the market. Today, Ukraine remains one of the most undercapitalized markets in terms of foreign investment in Eastern Europe.
GOVERNMENT ASSISTANCE The Government was helpful without too much interference.
OBSTACLES Political uncertainty (frequent government reshuffles and lack of a comprehensive reform programme under ex-President Leonid Kuchma; Stormy Presidential elections in 2004; Uncertainty ahead of parliamentary elections in 2006; Unstable and undeveloped regulatory environment (central bank regulations complicating purchase of Ukrainian shares for foreign clients; lack of modern stock market infrastructure, namely an electronic clearing/settlement system; parliament's long-time failure to approve modern
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legislation on joint stock companies and on protection of minority shareholders’ rights)
Action by the new government in alleviating problems The new administration is clearly aware of how important these reforms are. So far, politics have dominated due to the parliamentary elections in March 2006, but now Dragon is much more optimistic about the outlook for domestic capital markets.
POSTIVE AND NEGATIVE DIFFERENCES IN DOING BUSINESS FROM A YEAR AGO In the past year, the regulatory environment has not changed significantly, but interest from foreign investors has increased substantially. Ukraine may look negative in the short-term due to the current political uncertainty, but Dragon and its clients hold a positive long-term view. The change is demonstrated by a sharp increase in stock market turnover in 2005 as well as strong M&A activity in various industries (banking, machinebuilding, food processing, etc.).
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