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7 Privatization, Enterprise Restructuring, and Capital Market Reform

Patrick Lenain, and Peter Cornelius
Published Date:
February 1997
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Bernard Drum

Ukraine was a late starter in privatization. Until mid-1994, privatization was painfully slow and there had been several false starts. The main reasons for this are well known and include lack of leadership, lack of consensus among decision makers, and weak institutional capacity. All areas of economic policy were affected by these problems but the results were particularly acute in privatization and enterprise reform. Lack of progress led to widespread spontaneous privatization and the establishment of strong de facto control over enterprises by the employees and managers. President Kuchma’s election in mid-1994, however, marked a turning point. A new chairman was appointed to Ukraine’s privatization agency, the State Property Fund, the privatization process was streamlined, and full support was given to the redesigned program by the main donors including USAID, EU/TACIS (European Union/Technical Assistance to the Commonwealth of Independent States), and the World Bank Group. Many, but not all, of the previous obstacles to rapid privatization have been removed. The immediate challenges are to remove the remaining obstacles and to rapidly complete mass and small-scale privatization. The next steps will be to complete privatization of the remaining enterprises, consolidate recent improvements in the supervisory and institutional environment for capital markets, and promote rapid postprivatization restructuring in the enterprise sector.

Progress to Date

At independence in 1991 Ukraine had an estimated 18,000 state-owned medium-sized and large enterprises and an estimated 45,000 state-owned small-scale enterprises. At the end of 1994 approximately 3,000 medium-sized and large enterprises and 7,000 small enterprises had been privatized. However, the precise status of the privatized medium-sized and large enterprises is difficult to determine. Some were closed joint-stock companies owned by the working collectives, others were corporatized enterprises still in government hands, and others were of indeterminate mixed ownership. Furthermore, in late 1994 parliament had approved a negative list of 6,000 medium-sized and large enterprises that were not to be subject to privatization. This negative list still applies and is still blocking full privatization of the enterprise sector.

During late 1994 and 1995 important improvements were made to privatization methodology by a series of decrees and resolutions. In summary, these included the following:

  • merging of the two previous parallel tracks for privatization into one under the control of the State Property Fund;
  • streamlining of enterprise preparation procedures for privatization with standard preparation packages, automatic valuation procedures, simplified approvals processes, and tight deadlines;
  • issuing of paper privatization certificates to the general population;
  • creation of a privatization auction network of over 1,000 bid collection sites in all oblasts;
  • launching of a national public information campaign on privatization;
  • approval of a list of 8,000 medium-sized and large enterprises for mass privatization; and
  • improvements to the methodology enabling rapid privatization of small enterprises.

During 1996 further improvements have been made, including:

  • issuing of index-linked savings (or compensation) certificates and removal of the nominal value floor price for shares exchanged in the auctions for these certificates;
  • improved incentives for enterprise managers who cooperate with the privatization process and deadlines;
  • streamlining agro-industrial enterprise privatization methodology; and
  • issuing of deadlines for the collection and redemption of privatization certificates.

The results of the above measures, although less than originally planned, are impressive. By mid-June 1996, over 70 percent of the population had collected their privatization certificates and over 9 million compensation certificates had been issued. Between January 1, 1995, and mid-June 1996, packets of shares in a total of 3,533 enterprises had been transferred to private hands. Of these enterprises, about 2,500 were more than 50 percent in private hands and about 2,050 were more than 70 percent in private hands. An estimated 450 additional medium-sized/large enterprises had had 70 percent of their ownership transferred to private hands through compensation certificate auctions and other standard privatization methods, but this number has not yet been confirmed. Small-scale privatization has proceeded extremely rapidly. At the end of June 1996, a cumulative 31,500 small enterprises had been transferred to private hands since 1991. This represents over two-thirds of the small enterprises in state hands at the time of independence, and if small-scale privatization continues at its current rate of about 1,500 enterprises a month, small-scale privatization in Ukraine will be 90 percent completed by the end of 1996.

Progress in the development of capital markets institutions and regulation has also been substantial over the last year. Prior to mid-1995, responsibility for regulating the growing number of market participants and the rapidly increasing secondary trade in securities resulting from the mass privatization program was fragmented among a number of agencies including the Ministry of Finance, the National Bank of Ukraine, the Antimonopoly Committee, and the State Property Fund. Control was completely inadequate and there was a serious risk of fraud and other abuses. The government created a new Securities and Stock Markets Commission in June 1995. Two presidential decrees, in November 1995 and March 1996, transferred responsibility to the Securities and Stock Markets Commission for supervision of investment funds, investment companies, registrars, and depositories. In addition, draft decrees have been prepared, with help from USAID and the U.S. Securities and Exchange Commission, that would transfer responsibility for remaining capital markets supervision functions to the Securities and Stock Markets Commission, including investor protection, broker dealers, trading systems, and self-regulatory organizations of market participants.

Meanwhile, temporary share registrars have been created at the privatization auction centers with the intention of transferring them to independent operators as soon as the latter become operational. With help from USAID and EU/TACIS, work has been continuing on helping the formation of independent registrars and embryonic self-regulatory organizations, including a broker/dealer self-regulatory organization that will operate an over-the-counter market for shares. A draft law on the future role of the Securities and Stock Markets Commission has passed its second reading in parliament, and work has begun on the preparation of a comprehensive securities law that will encompass all the individual decrees under which the Securities and Stock Markets Commission has operated and will continue to operate pending its approval.

The number of market participants has been growing rapidly since privatization started to gather momentum. There are well over 350 investment funds, companies, and trusts licensed by the State Property Fund to invest in privatization certificates. About 60 percent of these are in five cities, with Kiev accounting for about one-quarter of them. About 80 percent of the privatization certificates collected are accounted for by only 30—40 funds. An additional 500 capital markets intermediaries have been licensed by the Ministry of Finance to invest in nonvoucher instruments and to offer brokerage and consulting services.

Short-Term Priorities

The most important short-term priority in privatization is to implement the program that has already begun. The State Property Fund has adopted the target of transferring at least 70 percent of each of 5,000 medium-sized/large enterprises to private hands (since January 1, 1995) by the end of 1996 and substantially completing small-scale privatization by the same date. To achieve this, the streamlined procedures recently designed for agro-industrial enterprise privatization will need to be implemented in the immediate future. These enterprises account for almost half the medium-sized/large enterprise pipeline and under the previous methodology their preparation for privatization could take well over a year. There is also an immediate need to modify the rules for compensation certificate auctions to allow share packets of greater than 30 percent of total numbers of enterprise shares to be offered. Only by doing this will sufficient numbers of shares in the larger enterprises clear the auctions, since only the compensation certificate auctions are allowed to clear without any floor price restriction. Continued political will is also needed to ensure that the improvements in streamlining the privatization methodology are not reversed, and in particular that no retrograde legislation is implemented that would slow down the medium-sized/large and small-scale privatization processes. Provided that there is no reversal of policy, donor support for the process should be maintained at least as long as necessary to achieve the critical mass of ownership change required to make the privatization process irreversible.

In the area of capital market reform, an immediate priority is to enact the package of draft decrees that has already been prepared, which will give the Securities and Stock Markets Commission a full mandate to regulate the markets- This need is becoming more and more urgent as mass privatization increases both the number of private shareholders and the trading volumes of shares by individuals and by collective investment vehicles. Approval by parliament of a comprehensive securities law could achieve the same purpose and is the medium-term aim, but experience has shown that it would be risky to hold the short-term future of the Securities and Stock Markets Commission hostage to unpredictable future decisions by parliament. Other short-term aims in capital market reform should be to transfer the share registries at the auction centers to independent operators wherever possible and to establish a timetable for the creation of a national depositary system for shares.

Medium-Term Strategies

If we take the medium term to include the two- to three-year period from early 1997, a number of priorities are already clear. First, the mass privatization process should be extended to all enterprises remaining on the list of 8,000 enterprises identified for privatization. Privatization of these enterprises should be completed by the end of 1997. Action also needs to be taken to privatize as many additional enterprises as possible on the negative list of 6,000 enterprises that are excluded from privatization. This may need a decision by parliament but other strategies such as corporatization and partial share sales are already being pursued by the State Property Fund. An examination of the negative list shows that about 2,500 of these enterprises are in the industry, agriculture, or service sectors and could easily be privatized. There are probably over 1,000 additional privatization candidates on the negative list, although many of the remaining “enterprises” are administrative, educational, or cultural institutions that are possibly not easily privatized.

As mass privatization draws to a close, attention will need to be focused on the remaining enterprises for which automatic mass privatization according to the established methodology is not appropriate. These could include large monopoly enterprises or other difficult cases including those in which a significant foreign investor interest has been shown. According to the legislation, shares from these enterprises should still be offered first to the employees, but packets can also be offered for sale through the public auction process, for cash through the Ukrainian Stock Exchange, through public investment tenders, or through private placement. The certificate auction infrastructure could also be used in a second phase to manage cash auctions for shares. The State Property Fund needs to develop methodologies for dealing with these special cases and particularly needs to develop the capacity to evaluate proposals from prospective investors for the purchase of blocks of shares. Over the medium term, privatization of public infrastructure and utilities should also be considered. Finally, there will be a need for the state to dispose of its residual shares in enterprises that do not serve a public purpose.

Capital markets actions over the medium term should aim to strengthen the supervisory and regulatory structures now being created. The aim should be for the self-regulatory organizations to create their own codes of conduct and criteria for membership and for membership in a self-regulatory organization to be compulsory for all licensed market participants. Much of the Securities and Stock Markets Commission’s role in market supervision would then be delegated to the self-regulatory organizations. The national depositary system for shares should also be made operational in early 1997. Donors should continue to provide technical assistance and training to capital market institutions and participants.

Beyond privatization and capital market development, a number of “second generation” reforms will be necessary to stimulate the restructuring of the enterprise sector after privatization. These include strengthening the role of the bankruptcy process in facilitating enterprise exit. Bankruptcy legislation may need to be improved, and the role of the recently created bankruptcy agency needs to be examined and modified if necessary. Enterprises need to be taken through the bankruptcy and liquidation processes on a pilot basis, both in and out of court, and the lessons learned from these pilots disseminated and used as feedback to improve the process. As postprivatization enterprise restructuring gathers momentum, the role of the Antimonopoly Committee needs to be examined and strengthened if necessary to ensure that anticompetitive enterprise behavior is minimized. Government and donors should support training programs for private enterprise shareholders and board members so that they can fulfill their role in improving enterprise governance. Training programs should also be supported for private enterprise managers.

There may be a need for proactive measures by government to accelerate social asset divestment by enterprises after privatization. Many of these assets are being transferred as a burden to the new enterprise owners during the mass privatization process, and help may be needed to facilitate their closure, divestment, or transfer to local authorities.

Heavy and arbitrarily applied taxation on enterprises has undoubtedly been one of the major reasons for the growth in the informal sector. The problems of the levels and administration of corporate taxation will need to be dealt with in the wider context of tax reform. Similarly, the whole area of corporate law will need to be examined and possibly overhauled if Ukraine is to develop a dynamic private sector and join the world’s market economies. Issues of foreign investment may also need to be addressed. At present, the main constraints on foreign investment are related to the investment climate, and priority actions are more concerned with maintaining a stable macroeconomic environment and open trade and price policies, ensuring private property rights, and limiting the state’s role in the productive sectors. However, in the medium term it might be appropriate for Ukraine to take more proactive steps to attract foreign investors. Similarly, there is a need to review continually the barriers to new entry and to running businesses in Ukraine, and to feed back the lessons from this review into government policy, if the promise of a private sector, market-driven economy is to be realized.

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