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Ukrainian Corporate Governance

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Ukrainian Corporate Governance UKRAINE / Corp Governance Initiating Coverage Corporate Governance. February 6, 2007 Nick Piazza [email protected] +380 44 207 5037 Konstantin Fisun, CFA [email protected] +380 44 207 5037 Ukrainian Corporate Governance From Ape To Man February 6, 2007 1 Corporate Governance. February 6, 2007 CONTENTS From Ape To Man 3 The Rise Of Self-Made Ukraine 3 Where Are We On The Darwin Scale? 3 Ukrainian Corporate Governance: Our Approach 4 Ranking System 4 Classifications 6 Scoring & Rankings 8 Ratings Round-up 11 Reporting & Disclosure 13 Investor Relations 14 Minority Treatment 16 Strategic Risks 18 Case Study: Privat - Bad News For Minorities? 19 Stock Market 20 Appendix 1: S&P Bank Ratings 21 Appendix 2: Ukrainian IFRS 22 Appendix 3: Company Profiles 23 2 Corporate Governance. February 6, 2007 From Ape To Man The Rise Of Self-Made Ukraine Two developments are currently shaping Ukraine’s business climate. On one side, the new economy has strengthened enough to become a significant force. A new generation of business owners is coming into the spotlight. People who started their new ventures in the late 1990’s – early 2000’s want to capitalize on their successful businesses. Their new more “self-made” background is instilled in their management and a new approach to capital markets is becoming the norm. “Red directors” are increasingly becoming a relics of the old epoch. On the other side, new political realities and the maturing market suggest a new quality of money is starting to flow into Ukrainian equities. This money is more demanding. It wants not only to know about a company’s business affairs, but also has a thirst for information about how the company is managed. Over 2004-2006 the Ukrainian market grew by leaps and bounds, with increasing liquidity. The PFTS has smashed through one historical maximum after another and found a new comfort zone well above the 500 mark since the beginning of 2007. The number of private placements and IPOs completed in 2006 was four to five times greater than 2005. The number and size of new equity offerings scheduled to take place in 2007 should make 2006’s numbers pale in comparison. This widening and maturing of the market, with new stocks on the supply side and new investors on the demand side, raise the need for more detailed information concerning corporate governance. Where Are We On The Darwin Scale? On the whole, Ukrainian companies are still far behind their western peers in terms of corporate development, most have never considered formulating a corporate strategy, the management feels uncomfortable facing simple questions from experienced shareholders. Ownership is generally highly concentrated, which does not facilitate the development of higher business standards. The supervisory boards of most companies are nothing more than rubber stamp committees for the beneficial owner. Of crucial importance is that the current legal system does not promote high corporate governance standards. Law provisions are formulated so loosely that publishing something like “Hey, last year was great” in a newspaper would likely meet all requirements. Timely and non-discriminatory dissemination of information is rare and the official publications where companies are required to publish their information are very primitive in quality. Ownership structure is only made public to a certain degree, (i.e. beneficial owners are generally cleverly hidden in order to protect their business from legal attacks from rivals), making getting detailed information about ownership plans and motivation a chore. Legal requirements are patchy and most companies can stay within the parameters of the law and reveal very little. The bulk of companies either have no websites or websites that contain little information of interest to shareholders and are rarely updated. A ray of light in this opaqueness is the memorandums at bond issuances, even local placements: they contain plenty of valuable information, thanks to the demanding nature of the regulations. The arrival of the Tymoshenko government in 2005 sent shockwaves through the business community and led many companies and business groups to improve their corporate governance in order to forge closer ties with western 3 Corporate Governance. February 6, 2007 financial institutions and thus protect themselves from possible hostile moves by the government. Despite the fall of the “Orange Crusaders,” many companies thereafter found attracting capital on western markets a much easier and cheaper alternative to more shady local forms of financing and continue to make strides towards the development of a corporate idea. Moreover, in 2006 a new law regulating the activities on capital markets brought Ukraine’s legislation another step closer to contemporary standards. Ukrainian Corporate Governance: Our Approach One of the goals of this report is to share our knowledge and experience in dealing with local companies to shed light on the corporate governance standards behind the numbers to help investors make more informed investment decisions. Unlike Russia, in Ukraine systematic analysis of corporate governance practices is scarce, especially from the point of view of a portfolio investor. In fact a recent study of corporate governance by Standard & Poor’s for thirty Ukrainian banks is about the only attempt made to tackle this issue. In order to fill the gap we are publishing our first report on Ukrainian Corporate Governance. We limit the scope of our research to several key areas, not venturing into the stringent requirements of an international Corporate Governance examination, which generally includes analysis of aspects such as management committees and supervisory boards, decision making processes, accountability of the management and internal company regulations. When placed alongside other aspects of corporate governance, these are the least developed in Ukraine. The relevant information is accessible in very rare cases, and we would encounter difficulties trying to differentiate companies in theses areas. For this reason we focus on aspects which in today’s environment are more important for decision making while investing into Ukrainian equities. Specifically taking into account that in recent years we have witnessed blatant disregard for minority rights in the form of massive dilutive share issues; many companies release financial reports sporadically that are often incomplete and management is unwilling to share their strategy with the investment community. For these reasons we have decided to make Reporting & Disclosure, Investor Relations, Minority Concerns and Strategic Risks the focal point of our report. Ranking System In Reporting & Disclosure we looked at the willingness of the companies to be forthcoming with their financial data and ownership structure. With the principle belief that the more willing a company is to be upfront with its financials and ownership the more developed in terms of corporate culture and well run the company would be. Three aspects were considered: availability of IFRS accounting, quality of UAS reporting, and disclosure of ownership. We used public sources, the companies’ own publications, and additionally contacted top-level management from each of the companies to judge their willingness to provide investors with financial information. The total possible score in this section has a range of [-2;4]. IFRS scoring ranged from 0.0/-0.5 depending on whether or not the companies reported their financials in accordance with IFRS to 2.0 if they were willing to provide IFRS reports to inquiring investors or made them publicly available. In looking at how closely the companies adhered to Ukrainian Accounting Standards, the scoring window ranged from -1.0 for statements that were obviously heavily distorted, to zero for those that suggested some manipulation, and 1.0 if the statements contained little or minor discrepancies. In cases where the companies were clearly against 4 Corporate Governance. February 6, 2007 sharing financial information a score of 0 was given. With foreign-based companies which obviously do not use UAS a score of 1.0 was given as not to punish these companies over a technicality. When looking at ownership structure, the scoring range was -1.0/1.0. This section was one of our most stringent. To avoid splitting hairs between companies that were all trying to hide their owners we only gave a 1.0 score to companies where ownership was common knowledge or provided at a reasonable level, while those companies that used opaque structures and schemes received a -1.0. Investor Relations. We judge investor relations using three criteria: management accessibility, what we have termed Public Face and company websites. The total possible score in this section has a range of [-3.5;4]. Management accessibility looks at the willingness of top management to meet with investors, arrange site visits, discuss company operations and share business strategies with the financial community - a key factor for giving investors insight into the company. This section allowed the widest range of scores, from -2.0 for companies that provided no accessibility, to +2.0 for quality accessibility entailing a willingness to meet and have frank discussions about the company’s business. The wide range of scores allowed us to better differentiate between companies. Public face, is the term we devised to encompass the company’s own efforts to keep the public informed of its activities and present itself to potential investors. Scoring ranged from -1.0 for those companies that rarely can be found in the media or at public events, 0.0 for those who appear sporadically and +1.0 for companies that can be regularly found in the press and initiating contact with the investment community. An examination of websites was also included in this section of our research as a high quality website serves as one of the easiest and most effective ways to get valuable information including everything from ownership structure to financials. As our research proved, those companies with the highest overall standards of corporate governance also had the most informative sites.
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