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How To Make Anti-Corruption Changes In Ukraine Irreversible?

Summary

What is Agrarian Fund?

Agrarian Fund as an example of a state-owned enterprise.

What was Agrarian Fund used for?

How we did it.

How to make anti-corruption changes in Agrarian Fund irreversible?

INTRODUCTION

Immediately take a note that this article does not contain a universal recipe for combating corruption in the economy and the public sector. Corruption, as an economic and social phenomenon, is multifaceted. So are the ways and tools for dealing with it.

I am not a government official. I am a former banker. For the last four years, I have managed a large Ukrainian state-owned company. The purpose of this article is to shatter the illusion that corruption in Ukraine is insurmountable.

Let me begin by saying that I am uniquely qualified to talk about this topic, because I have managed my own case study of successfully overcoming corruption. This is what I will talk about.

During my visit to Washington, D.C. in June 2019, I delivered a report on a similar topic at the distinguished Atlantic Council. I started by asking the audience a standard question: What do you know about Ukraine?

I received three highly anticipated answers:

- That we have a newly elected president, a former actor. Like Ronald Reagan.

- That our country is in a state of frozen conflict with Russia

- That Ukraine is a country where corruption flourishes.

Indeed, corruption has become synonymous with Ukraine. But this did not happen in the last five years. This occurred during the twenty five years since Ukraine declared independence in 1991.

Following the Revolution of Dignity in 2014, Ukrainians had high hopes this association would disappear. But it did not. At the same time, during the five years since Russia invaded Ukraine, the United States has actively supported initiatives in Ukraine to combat corruption.

It was with the support of the United States that the independent National Anti-corruption Bureau of Ukraine (NABU). Its function is investigation - like the U.S. Federal Bureau of Investigation (FBI), except NABU only investigation cases of corruption. NABU is independent, even from Ukraine’s Prosecutor General’s Office (PGO).

In parallel, an independent agency under the PGO was created to investigate corruption, the Special anti-Corruption Prosecutor’s Office (SAPO).

NABU and SAPO receive cooperation from all existing Ukrainian law-enforcement agencies: the SBU State Security Service, Interior Ministry, and so on. NABU and SAPO have their own special armed units, which can act independently of the SBU and police.

The Nation Agency on Corruption Protection (NACP) was also created. It deals with bureaucratic issues. Thanks to NACP, all Ukrainian officials are obliged to file electronic asset declarations. Now, the income and assets of officials are made public. They can be analyzed by journalists, civil society activists and investigators. People today are waiting for the work of the High Anti-corruption Court to start. Many believe this specialized court will successfully root out corruption.

I hold a different opinion. I do not think the court will be a guarantee for overcoming corruption.

Let’s first think about what we will consider a successful fight against corruption.

What criteria can we establish for success?

When the first 100 corrupt Ukrainians be sent to prison?

When the first 1,000 corrupt Ukrainian officials be sent to prison?

When the Washington Post writes an article appear on the front page declaring that corruption in Ukraine has been overcome?

Will people then speak about Ukraine differently?

What are the real criteria for fighting corruption?

Moving up in the Doing Business ranking? We are already moving up, taking half steps, enjoying partial successes.

At the same time, everyone understands that corruption in Ukraine is still alive and remains a big problem. Perhaps, the global solution to overcoming corruption in Ukraine will be born in the minds of analysts of the Atlantic Council.

***

My goal and mission is to talk to you about one case study. I emphasize, I do not have global solution for eradicating corruption and I am not seeking to become a prosecutor, who will tell you how to fight against corruption properly. I only want to tell you what I understand. I will tell you how we got rid of corruption in one previously corrupt state-owned enterprise - Agrarian Fund.

My main thesis: Ukraine can only defeat corruption using economic means, not through law enforcement means.

What is the Agrarian Fund? It is difficult for Americans to understand the structure of state-owned assets in Ukraine.

The Agrarian Fund is a large structure comprised of departments/enterprises subordinate to Ukraine’s Ministry of Agriculture and Food. In addition to the Agrarian Fund there is state-owned Grain Corporation of Ukraine, Ukragroleasing and others.

But my goal and mission is to present the case of our company and to explain how we got rid of corruption in one of Ukraine’s shadiest state-owned companies.

We accomplished this not by using force but by using economic tools.

What is Agrarian Fund?

Agrarian Fund is one of several specialized large state-own companies that was created from state budget funds and put under the management of Ukraine’s Ministry of Agrarian Policy and Food.

The ministry manages more than 650 difference state enterprises. Some of the largest and best known are Ukragroleasing, Ukrspirt, the State Grain Association and Agarian Fund.

Since 2015, only one them - Agrarian Fund - has demonstrated a positive dynamic of activity and development in different indicators.

This positive dynamic sometimes causes envy and dissatisfaction among our colleagues from other state-owned companies and ministry officials.

Agrarian Fund as an example of a state-owned enterprise

The state specialized budgetary institution - Agrarian Fund, established in the 2005th year to minimize price fluctuations in the market for agri products through financial and commodity interventions.

What was Agrarian Fund used for?

In Ukraine’s small, closed economy of 2005, Agrarian Fund could have been used as a working model for replacing direct price regulation, which had been adopted during Soviet times.

Let’s first take a look at the business model proposed by our predecessor.

Its role was to conduct commodity interventions to stabilize prices during periods when there were shortages of goods, that is, the sale of goods below market prices.

And to conduct financial interventions, the redemption of goods from the market, leading to the appearance of a substantial surplus and a decrease in prices for them. Obviously, the old Agrarian Fund could not be profitable. It was a planned, unprofitable enterprise.

By forcing the company to work against economic principles, the state independently engendered elements of corruption in it. Accordingly, law enforcement agencies opened criminal cases, which were closed in exchange for bribes worth a fraction of the volume of illicit activities. An entire cycle of corruption was born.

What did the state receive in return?

Agrarian Fund managers purchased grain and sugar (conducting so-called financial interventions) using state budget funds annually allocated to the ministry. The very same commodity was the object of theft, as well as the source for corruption during storage and transportation.

Agrarian Fund’s director last year declared that the continued operation of the enterprise would be inexpedient. Only 5,000 tonnes of grain (of doubtful quality) and about 50,000 tonnes of sugar remained on the company's balance sheet, which had expired more than a year ago. At the same time, the recorded amount of embezzlement since the start of operations amounted to 420,000 tonnes for the sum of UAH 1.4 billion (about $215 million). Two dozen criminal cases were opened. There is no money in Ukraine’s state budget to maintain this enterprise, which for almost a decade received funds from Ukraine’s Treasury. Agrarian Fund employs five permanent staff, is involved in dozens of criminal cases and is in a pre-liquidation state.

The reputation of the enterprise so toxic that even ministry officials have no desire to even address issues related to its liquidation, the same issues they themselves have created.

The status of Agrarian Fund today is legal collapse based on collective irresponsibility. The situation is not unique to Agrarian Fund, ,but to all state-owned enterprises.

Agrarian Fund as an enterprise that “happened”

Agrarian Fund was created to be an operator on the domestic grain market not subject to the law on price regulation.

Agrarian Fund was created in 2013 under disgraced ex-President Viktor Yanukovych. The real reason for creating Agrarian Fund is controversial. Some say it was specially invented as a vehicle for embezzling and withdrawing state budget funds.

This explanation is plausible, given the fact that in early 2014, when Yanukovych and his entourage fled Ukraine, almost half the authorized capital generated by the state, as well as UAH inventory loss balances derived by fraud by previous fund managers in annexed Crimea, was withdrawn from Agrarian Fund.

But we can only proceed from the current situation and correct it. This is what our team has been doing since January 2015, when we took charge of an enterprise with working assets amounting to UAH 2.255 billion, including almost UAH 700 million in long-term deposits in a single bank. And more than UAH 300 million commodity balances in areas close to fighting in eastern Ukraine, as well as UAH 220 million in controversial VAT payments to be reimbursed. And the resistance from within the system!

Nevertheless, we set sail…

How we did it

Following the Revolution of Dignity in early 2015, new management was hired to run Agrarian Fund. I was a successful commercial banker and won a fair competition to head the board of Agrarian Fund.

I managed to form a new team. I hired key personnel, mostly people involved in financial management, crisis management, risk management, qualified lawyers and managers, who were ready for the challenge of overhauling the enterprise.

After managing to change the system of motivation within the enterprise, we began paying attention to the whole team. We selected qualified personnel in a competitive labor market and created decent working conditions for the employees whom we valued and who valued the enterprise.

Agrarian Fund in 2015 introduced a Key Performance Indicator-based payment system, employee health insurance, social security, staff training, internships, a personnel reserve and loyalty system. Old timers in the enterprise broke down in tears when the enterprise for the first time ever congratulated their families on the first corporate holiday with candy boxes for their children.

Today enterprise workers receive higher wages than average civil servants in Ukraine. This has fueled motivation that has allowed us to set ambitious goals and achieve results. Since 2015, net assets of the enterprise have grown from UAH 3.7 billion to UAH 6.3 billion. The company’s profit for the budget in the first year of our work amounted to UAH 411 million, compared to UAH 1.7 billion in losses for the previous year.

At the very start, thanks to the “work” of Agrarian Fund’s managers during Yanukovych period, our working current assets fell from UAH 5 billion to UAH 2.26 billion, due to borrowed funds. But we have already increased our assets to UAH 6.28 billion. And we found solutions, like leverage, to increase the turnover of the company and conduct other successful activities without asking for money from the state.

In order to evaluate these results, recall the macroeconomic environment in Ukraine for the past four years. A war is underway in Ukraine. High inflation has only recently been tackled and not everyone believes in exchange rate stability. Accordingly, the volume of lending to the agroindustrial complex has been at a standstill for the past four years. One of the main reasons for this is the level of interest rates. Even Agrarian Fund, a large state-owned enterprise and first-class borrower, are forced to take out loans from commercial banks at an average rate of 23.5% per annum!

WACC for our company is 19.9%. It consists of a share capital value of 14.3% for government bonds and an average effective rate of 23.5% for bank loans. Even in these conditions, we return the money to our lender, in addition to generating profits for the budget. I think this in itself is success.

Agrarian Fund is engaged in trading.

We had to slightly reduce our participation in the grain market, but we significantly increased the share of the Agrarian Fund in the fertilizer market. In parallel, we continue to be one of the leading lenders for farmers.

Ukraine’s banking system remains in a state of flux. Although some kind of financial stabilization was achieved, at current rates, banks cannot lend to farmers. Hardly half of the loans of farmers are of high quality. But this is the best indicator among other industries.

At the same time, our lending share among remaining banks ranges from 10% to 50% of loans for sowing.

We see a huge potential in the fertilizer market. Our forecast share in it is about 10-15% of the market. The fact is that in Ukraine the growth of fertilizers is increasing. We forecast a jump in sales over the next five years, even in the next four years, because of Ukraine’s record grain yield growth.

What exactly did we do and why do the numbers in our reports indicate achievement?

We simply introduced Western corporate procedures within the company and a transparent audit system, thanks to which we overcame internal corruption in the company.

  1. We have segmented our customers, and accordingly, approaches and standards for sales and service products. For medium and small businesses in the regions these are fixed standard procedures. There is a standard for customer evaluation and monitoring (scoring). With large clients, we take a personal approach, studying and understanding customer needs, improving individual relationships and solutions and increased attention of services in the coordination of conditions and contracts.
  2. We changed the organizational structure of the enterprise to provide modern distribution of functions of our enterprise’s divisions, including the front, middle and back office, divisions engaged in the administration and maintenance of operations, control operations and risk monitoring.

  1. We developed a system for delegating authority in making personal and collective decisions and created a system of control for monitoring grants of authority.
  2. We introduced permanent collegial decision-making bodies: the Risk Management Committee, Budget Committee, and Personnel Committee.
  3. We introduced preventive measures to prevent corruption in the form of a system of regulations, regulations and standards.
  4. We developed and implemented a system of regular reports and monitoring.
  5. We strengthened control and audit of the Agrarian Fund. Today, the Agrarian Fund is undergoing both an internal audit for the Board, which is maintained by the Internal Audit Service, and an external audit for a shareholder. Agrarian Fund is the only state-owned enterprise that conducts an external audit of international audit companies, and this was solely due to our initiative. So, in 2015, the audit was conducted by BDO, in 2016-2018 - by Backer Tilly. All reports are publicly available on the company's website.
  6. On the recommendations of anti-corruption bodies, we have developed an internal anti-corruption policy. Namely, the structure of the company provides for a specially authorized person to identify and combat corruption. Functionally, this anti-corruption worker is subordinate to me, as Chairman of the Board and formally to the shareholder represented by the Ministry of Agrarian Policy and Food.

During the four years that I have led the enterprise, management has developed a zero tolerance for corruption. Therefore, Ukraine’s five anti-corruption agencies have had nothing to do in Agrarian Fund. Our internal audit service and economic security service itself detects all cases of theft. And where we recorded cases of theft, we ourselves collected evidence gave it to law enforcement agencies.

At the initiative of NABU, there are currently two cases under investigation involving the enterprise. One has been under investigation for more than two and a half years and, I think, due to the absence of corpus delicti, the case will soon be closed. The second was opened in February 2019 and is still being examined by NABU detectives. It involves the Agrarian Fund’s commercial activities, which during four years brought the state UAH 550 million while paying UAH 480 million in taxes and taking zero funds from the state. I am certain the second case will be closed after NABU’s examination is completed.

In my opinion, such indicators of obligatory payments to the budget are already the main evidence that today corruption in the Agrarian Fund under our Board does not exist. Perhaps the situation I have described is too self-congratulatory?

How to make anti-corruption changes in Agrarian Fund irreversible?

All of the above changes at Agrarian Fund are based only on our experience, knowledge and will. Are these changes irreversible?

The answer, of course, is NO. Unfortunately, they are reversible. Because the external environment has not yet accumulated a critical mass of objective and subjective factors for a fundamental change. Only our will has prevented the enterprise from returning to the usual old rules of corruption.

Firstly, the political factor remains a priority when, according to the quota principle, interesting enterprises are “distributed” under political agreements. And the Agrarian Fund today is much more attractive than four years ago, when I won the competition and started from scratch.

Secondly, our main shareholder - the state, represented by Ukraine’s Ministry of Agrarian Policy and Food, has still not formed the Supervisory Board, which should include four independent members, and, accordingly, the shareholder represented by the Minister of Agrarian Policy.

Examples of what can happen when a company resists the actions of a corruption system can be at least our examples of delaying the approval of the company's Financial Plan. For example, in 2017, the financial plan was adopted in July 2017, after seven months enterprise work; in 2018 - in June, after six months; in 2019 - in April, after four months (!)

Thirdly, possible abuses of the new Board and employees

Fourth, rejection of external audit and the distortion of internal audit/reporting

And then we put such a question before ourselves, before the current management of the Agrarian Fund:

- What legal mechanism is possible if the shareholder represented by the state for some reason is not ready to privatize or liquidate the company (asset) at the current time, but at the same time it is necessary to minimize the risk of returning to the old management system or the emergence of other new corruption schemes, risks of losses and waste of public funds?

In order for the state to further develop democratically, its economy should grow using market mechanisms. In a competitive environment, donors are confident in the targeted use of funds and their efficiency, and investors in protecting their investments there is a popular opinion. All assets in the public sector should be maximally privatized, with the exception of strategic objects, industries and companies.

In general, I support this view.

But what else can be done if the privatization of an object is unprofitable in the near term and will force the state to pay extra for someone to take such an object?

We turned to the analytical group Ukraine Economic Outlook, which, based on our external audit reports of the reputable international company Baker Tilly, calculated three options for the future Agrarian Fund.

The first scenario is liquidation.

The enterprise today remains too poor to be liquidated. Auditors have indicated a liquidation value that would leave the state with an uncovered loss of UAH 2.4 billion, considering obligations on T-bills paid into our authorized capital - UAH 5 billion, considering the exchange difference. Losses for the budget under this scenario are self-evident.

The second scenario is privatization.

Our auditors calculated the value of the company based on discounting future cash flows.

Unfortunately, even without calculating the value of the brand, which today has some value, the market price of the Agriarian Fund’s stock capital does not exceed UAH 2.7 billion, with UAH 5 billion owed to Ukraine’s Finance Ministry. Others will also need to be compensated if they become owners of Agrarian Fund in its current state. Because the fund’s net assets are still in the negative.

However, economic theory teaches us that there are no impossible situations. And we have thought up a variant according to which the company could continue to generate positive cash inflows with sales increasing exponentially over the next several years.

What is necessary is to retain the model that will continue to interest management in doing the work it is doing today. For government, it is necessary to guard against the risk that the Agrarian Fund will take even one kopek from the budget and provide a 100% guarantee that the Agrarian Fund will continue to bring profit to the budget.

What is crucially important is that the balance of the company will be positive. The company’s shares will remain in government ownership. That’s why we call this the concession scenario.

The bottom line is that the concession payment will provide income for the state at a level not lower than the amount of dividends transferred today and will allow by 2023 to fully restore the value of the company, which is today UAH 2.5 billion. So, the concession option, which I propose to consider today, consists in the obligation of the concessionaire at first to use all the profits to create reserves for losses of previous years. According to our calculations - this will allow the company to withdraw from the negative value to zero — over the first three years. Further, the concessionaire undertakes to pay a 25% net profit as a concession payment. I want to note that the company's value at this time will continue to grow and the state, as a 100% shareholder, will monitor the work of the Agrarian Fund through an external audit.

At the same time, other functions related to operating activities will be transferred to the concessionaire, which will improve management efficiency, speed and efficiency of decision making and, most importantly, prevent the risk of resumption of corruption schemes in the Agrarian Fund. Accordingly, when the net worth of the Agrarian Fund ceases to be negative, and the state covers the losses of the previous years - we will be able to return to the issue of privatization as the next step.

The state will not only receive guaranteed operating income over the next five years, but will also retain 100% of its shares, which will significantly increase in price over the next five years.

Let's not forget that all these years, the Agrarian Fund, along with concession payments, will pay at least half a billion taxes to the budget each year.

Not to mention the fact that the company performs the important functions of supporting lending to farmers in a poorly functioning banking system.

Who can become a concessioner?

Most likely, it will be someone from the domestic market; perhaps grain operators Kernel or MHP, or possibly the OKKO oil trader. It could also be someone from the global market participants - Cargill, Bunge or CHS. Of course, one cannot completely reject the current management as a potential concessionaire. The results of the last three years and the system of established relations prove the loyalty of our chosen business strategy and steps to attract borrowed working capital to increase financial leverage.

As for the government, which will decide to hold such a competition on the choice of the concessionaire, and for the Agrarian Fund until the moment when privatization is attractive, I would recommend paying attention to this team of managers, including signing certain contracts.

I would recommend scaling this practice of concessions for other objects that are not of interest at the current moment, but may be potentially interesting for privatization in a future period: prior to privatization and/or for privatization, it is possible to have hold tenders during privatization, i.e. to select the concessionaire and fix these conditions in the form of contracts. Thus eliminating the risks of participation of unqualified participants, their shifts under political agreements, ineffective solutions and theft.

How experience of concession can be scaled: OPP

In order to understand whether the example of a concession can be scaled to other, related sectors of the economy, and how it can help eliminate blood clots in other state giants, consider one of the most difficult examples of recent years, a company that still cannot be privatized - the Odesa Port-Side Plant (NYSE:OPP).

Debt of OPP today is $340 million. Accordingly, its privatization cost, instead of the record $1 billion offering price in 2010-2013, dropped to $540 million in 2016 … and in 2018 to $54 million.

Why was it necessary to decrease the asking price 12-fold?

Traditionally, the plant operated according to one formula:

1) Holding a competition for work on a raw material basis.

2) The «necessary» company wins with an insignificant share capital, assets and, accordingly, without obligations, in case of losses.

3) The operation of several months, as a result - the loss of the IPF, open and lingering criminal cases.

Such a mechanism of work is impossible if a shareholder is not interested in it. And who is the beneficiary of such a scheme? This is the result of parliamentary agreements promulgated by a political actor, who appoints the director or members of the OPP board. These people are no longer playing the classic role of management, but anticipating the targeted bankruptcy scheme of the company.

We, the current management of the Agrarian Fund, have already looked at the problems of the plant, its business model and needs, and offered the government a way out of the situation, our vision of how an anti-crisis program can be implemented, how a plant can be made investment-attractive for privatization.

At the same time, we immediately abandoned the model of appointing “looking” or “controllers” to appoint as OPP board members. We offered the government to fix the conditions of interaction, management and control in the form of a concession agreement, where the Agrarian Fund could act as a concessionaire (in this case).

And this can give a synergistic effect both for the OPP - a plant that produces mineral fertilizers, and for the Agrarian Fund - the operator of mineral fertilizers in the domestic market and a subject with the practice of export operations. Capitalization of such cooperation would give a significant synergistic effect and would only contribute to the growth of the capitalization of two large companies, 100% of whose shares belong to the state!

Today we are experiencing a time of change. In which it is important, criticizing the mistakes of predecessors, not to lose the positive experience that was gained in the previous five years. I sincerely hope that our innovative, proven-in-practice proposals will not be lost in the following years “in a pile of papers.” I believe that concession, as an economic method of clearing “Augean stables” in the financial balance sheets of many state enterprises, is the most effective way of disposing of state assets. It is also the one that will bring maximum profit to the state as an owner.