The Ukrainian Defense Industry — Challenges and Proposals for Reform

defense The Ukrainian Defense Industry — Challenges and Proposals for Reform

of Ukraine, taking into account NATO stand- ards; a number of SC Ukroboronprom’s members signed cooperation agree- ments / memorandums of understand- ing with foreign defense contractors (e.g., Rockwell Collins, Aeroscraft, Aselsan); the defense hub uniting public and private Anastasiya Artem defense contractors in Ukraine was estab- BOLKHOVITINOVA HRYTSAK lished. At the same time, the overall pace of defense reform leaves much to be desired Ph.D., Legal Director, DLA Piper Senior Compliance Manager, Kyivstar and a number of problems and challenges remain unsolved. Below we outline some of the problems and challenges that the de- ur country faces serious na- — On 14 June 2017 the Government fense industry faces. tional security challenges of Ukraine adopted Resolution No. 398-r, that require advanced war which establishes the principal directions Challenges and Problems fighting capabilities sup- for the development of arms and military (i) Ukroboronprom’s Reform ported by a robust defense equipment in Ukraine. State Concern Ukroboronprom (UOP), Oindustrial base. Ukraine also needs to build — On 8 June 2017 the Ukrainian Parlia- established in 2010, is the largest state de- globally competitive capabilities and in- ment introduced changes to the National fense holding group in Ukraine with about crease defense industrial cooperation with Security Law of Ukraine stating that coop- 130 members operating in five major indus- other countries. Therefore, we believe that erating with NATO and becoming a NATO tries as well as in R&D and export-import reform of the Ukrainian defense industry is member are among the main principles of activities. Despite a number of announced a top priority. Ukrainian foreign policy. reforms, UOP is still perceived by many mar- In our article last year called Defense, — On 9 August 2017 the Government of ket participants as a heavily inefficient and which was published in the Ukrainian Law Ukraine approved the agreement with the non-transparent holding company where Firms Review 2017, we described the ma- NATO Support and Procurement Agency most of the reforms are announced but not jor problems in the industry that need to (NATOSPA), which will reportedly allow implemented in practice. Performing an in- be addressed to catalyze reforms and to Ukrainian enterprises to participate in NAT- dependent audit/due diligence as well as make the industry a major driver of eco- OSPA tenders as well as to purchase goods, developing and implementing a clear plan nomic growth in Ukraine. Unfortunately, works and services from non-residents of for reforming UOP with the involvement of despite numerous public statements and Ukraine through NATOSPA’s services. professional international strategic, financial declarations, the vast majority of issues — The Draft Law of Ukraine On the Na- and legal advisors are considered necessary have not been addressed to date. Below tional Security of Ukraine was prepared and tools for transforming UOP into a modern we outline the most recent develop- approved by the National Security and De- Western defense contractor. For such pur- ments, challenges faced by the industry fense Council. poses, in November 2017 UOP announced a and share our thoughts on required re- — On 11 January 2018 the Government tender for the enlisting of strategic, legal and forms. of Ukraine adopted a resolution consolidat- financial consultants (consortium of consult- ing existing lists of dual-use goods into a ants), that will conduct UOP’s audit and will Recent Developments single unified list of goods for the purposes advise on the UOP’s transformation. The ten- During the period of 2017 into the be- of export control, which is one of the impor- der has not yet been held and the deadline ginning of 2018, a number of strategic docu- tant steps of reforming the national export for submission of the tender applications has ments regulating the defense industry were control system. already been postponed several times. adopted, particularly: In addition to legislative developments, — In March 2017 the Government of a number of other important events in the (ii) Lack of Transparency Ukraine adopted the State Target Program industry took place in 2017. Among others, The defense industry of Ukraine is per- on Creating and Developing the Produc- corporatization of SE Antonov and SE Plant ceived as a highly opaque sector which dis- tion of Ammunition and Special Chemical 410 of Civil Aviation into public joint stock courages large investors from entering the Products. companies was launched; the Ministry of market. A number of fundamental legal acts — On 24 May 2017 the Government of Defense of Ukraine signed a memorandum which lay down a roadmap for defense in- Ukraine adopted the State Target Program with Microsoft Ukraine on cooperation re- dustry reform are classified and are, there- of Reforming and Developing the Defense garding the introduction of modern infor- fore, not publicly-accessible. Such acts in- Industry of Ukraine for the period till 2021. mation technologies in the defense sector clude the State Target Program of Reform-

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ing and Developing the Defense Industry Ukrainian exporters also raise the need the major drivers of the Ukrainian economy. of Ukraine for the period until 2021 and the to educate the representatives of the export At the same time, as Michael Carpenter, a State Program for Developing the Military control and customs authorities, which will non-resident senior fellow at the Atlantic Forces of Ukraine for the period until 2020. make export control more efficient and less Council, stated in his recent article: no major Another example is defense procurement time consuming. Western defense company will take the risk under the state defense order of Ukraine. of investing in Ukraine so long as the sys- Procurement is mostly classified, which (iv) No Effective Mechanisms for Coop- tem is opaque and property rights are not results in a lack of control over the funds eration between SOEs and Private Compa- adequately guaranteed. spent and a lack of accountability (allegedly nies Considering the above, the authors be- military and dual-use items are procured SOEs currently make up the majority lieve that the following measures need to through single-source contracts resulting of defence sector enterprises, and we can be taken for the purposes of successful re- in excessive prices and poor quality goods). see interest coming from both international form of the Ukrainian defense industry: and local investors to cooperate with such — Establishment of effective corporate (iii) Export Control Reform SOEs. At the same time, outdated and rigid governance, oversight and accountability The current system of export control laws do not currently provide for effective in the defense industry, including estab- in Ukraine is outdated, non-transparent mechanisms for cooperation between SOEs lishment of supervisory councils with inde- and inefficient. Although the need to intro- and private investors. For example, the Law pendent directors in SOEs. duce e-declarations, shorten the terms of of Ukraine On Management of State Property — Privatization of non-strategic SOEs. review of documents and issuance of au- Objects includes a provision specifying that — Performing an independent audit thorizations and to simplify export control the establishment of commercial enterpris- along with developing and implementing a procedures has been announced on nu- es on the basis of state-owned property is clear plan to reform UOP with the involve- merous occasions, the relevant initiatives prohibited unless the Government’s stake ment of professional international advisors. were not systematized, even at the level of in such an enterprise exceeds 50%. Another — Decreasing the level of secrecy draft legislation. As an example, in practice example is the general prohibition on SOEs (amount and types of classified information) it takes 30-45 days for an exporter to get acting as the founders of joint ventures (JVs) in the industry, including in the defense pro- all the necessary authorizations, which in established by the Government’s decree curement process. many instances results in the withdrawal of No. 24-92 dated 31 December 1992. Such — Clear distribution of powers between the counterparty from the contemplated regulations keep private (including foreign) UOP and other state bodies. transaction. market players at bay. — Reforming export control — introduc- Another area of concern is conflict of in- On 14 July 2016 a number of amending e-declarations, shortening the terms for terests at the level of UOP being simultane- ments were introduced to Ukrainian laws issuance of authorizations and conclusions, ously a market player and regulator. Specifi- enabling Ukrainian SOEs engaged in aircraft simplification of export control require- cally, companies seeking to export military construction to set up joint ventures both in ments for export of goods to NATO coun- goods have an obligation to coordinate all Ukraine and abroad. As far as we are aware, tries, strengthening end-user control, edu- such transactions with UOP and obtain its no such joint ventures have been estab- cation of representatives of export control consent for the conclusion of certain types lished so far. and customs authorities. of contracts. This provides UOP with addi- — Amending Ukrainian legislation in tional leverage within the market along with Proposals terms of JVs, PPP — allowing SOEs to act potential access to the companies’ com- The defense industry of Ukraine still as founders/participants of the JV, cancel- mercial data. has huge potential and can become one of lation of the 50%+ state share requirement.