Report on the Observance of Standards and Codes (ROSC) Corporate Governance Public Disclosure Authorized
Corporate Governance
Public Disclosure Authorized Country Assessment
Ukraine October 2006 Public Disclosure Authorized Public Disclosure Authorized Overview of the Corporate Governance ROSC Program
WHAT IS CORPORATE GOVERNANCE? THE CORPORATE GOVERNANCE ROSC ASSESSMENTS Corporate governance refers to the structures and processes for the direction and control of com - Corporate governance has been adopted as one panies. Corporate governance concerns the relation - of twelve core best-practice standards by the inter - ships among the management, Board of Directors, national financial community. The World Bank is the controlling shareholders, minority shareholders and assessor for the application of the OECD Principles of other stakeholders. Good corporate governance con - Corporate Governance. Its assessments are part of tributes to sustainable economic development by the World Bank and International Monetary Fund enhancing the performance of companies and (IMF) program on Reports on the Observance of increasing their access to outside capital. Standards and Codes (ROSC). The OECD Principles of Corporate Governance The goal of the ROSC initiative is to identify provide the framework for the work of the World weaknesses that may contribute to a country’s eco - Bank Group in this area, identifying the key practical nomic and financial vulnerability. Each Corporate issues: the rights and equitable treatment of share - Governance ROSC assessment reviews the legal and holders and other financial stakeholders, the role of regulatory framework, as well as practices and com - non-financial stakeholders, disclosure and trans - pliance of listed firms, and assesses the framework parency, and the responsibilities of the Board of relative to an internationally accepted benchmark. Directors. n Corporate governance frameworks are bench - marked against the OECD Principles of Corporate Governance. WHY IS CORPORATE GOVERNANCE IMPORTANT? n Country participation in the assessment process, For emerging market countries, improving corpo - and the publication of the final report, are volun - rate governance can serve a number of important tary. public policy objectives. Good corporate governance reduces emerging market vulnerability to financial n The assessments focus on the corporate gover - crises, reinforces property rights, reduces transaction nance of companies listed on stock exchanges. At costs and the cost of capital, and leads to capital the request of policymakers, the ROSCs can also market development. Weak corporate governance include special policy focuses on specific sectors frameworks reduce investor confidence, and can dis - (for example, banks, other financial institutions, courage outside investment. Also, as pension funds or state-owned enterprises). continue to invest more in equity markets, good cor - n The assessments are standardized and systematic, porate governance is crucial for preserving retire - and include policy recommendations. In response, ment savings. Over the past several years, the impor - many countries have initiated legal, regulatory tance of corporate governance has been highlighted and institutional corporate governance reforms. by an increasing body of academic research. n Assessments can be updated to measure progress Studies have shown that good corporate gover - over time. nance practices have led to significant increases in economic value added (EVA) of firms, higher produc - By the end of June 2005, 48 assessments had been tivity, and lower risk of systemic financial failures for completed in 40 countries around the world. countries. REPORT ON THE OBSERVANCE OF STANDARDS AND CODES (ROSC) Corporate governance country assessment Ukraine October 2006
This report assesses Ukraine’s corporate governance policy framework and enforcement and compliance practices. It highlights recent improvements in corporate governance regulations, makes policy recommendations, and provides investors with a benchmark against which to measure corporate governance in Ukraine. Several developments have worked to improve the corporate governance environment in recent years, including high levels of economic growth and a growing demand for capital growth in Ukrainian industry. The equity market has boomed, and over 45 companies have issued depository receipts abroad. A corporate governance code was issued in 2003, and a number of private-sector and donor initiatives have continued to work to promulgate the code and introduce good practice at the company level. Several reforms have been carried out, including the passage of a new securities law. However, many factors continue to impede reforms. Company law is widely recognized to be inadequate. The large number of joint stock companies and the lack of transparency of the corporate sector continue to pose a supervision challenge. Key institutions (including the central depository and the company registry) are in their early stages of development. The report recommends (i) a variety of legal reforms, including a revised company law that would be enacted by the Parliament, (ii) institutional strengthening, including focusing the enforcement activities of the SSMSC on large and traded companies, and (iii) enhanced listing requirements for the top tier of the PFTS, including a requirement to “comply or explain" compliance with the Ukraine Corporate Governance Principles.
Acknowledgements
This update on assessment of corporate governance in Ukraine was conducted in February 2006 by Alexander Berg and David Robinett of the Corporate Governance Department of the World Bank, as part of the Reports on Observance of Standards and Codes Program. The report draws on a number of published and unpublished studies of corporate governance by the IFC Corporate Governance Project in Ukraine and the Europe and Central Asia Region of the World Bank. Messrs. /Mmes.: Paul Birmingham, Sue Rutledge, Roman Zyla, Mark Davis, Angela Prighozina, Marie-Laurence Guy, Behdad Nowroozi, Tatiana Nenova, and Frederic Gielen provided advice and comments. The assessment reflects technical discussions with the State Commission on Securities and Stock Market, First Stock Trading System, MFS, SigmaBleyzer, Ukrainian Association of Investment Business, Professional Association of Registrars and Depositaries, Ukrainian Corporate Governance Center, ING Bank, Ukrainian Association of Accountants and Auditors, Stock Market Development Institute and other leading experts on legal, accounting and auditing issues, academics, capital market issuers, institutional investors and stakeholder groups. This report incorporates the comments of the Ukraine Securities and Stock Market State Commission.
Table of Contents
Country assessment: Ukraine...... 1 Market profile...... 1 Key issues...... 3 Investor protection ...... 4 Disclosure ...... 4 Company oversight and the board...... 5 Enforcement...... 6 Recommendations ...... 6 Summary of Observance of OECD Corporate Governance Principles ...... 11 Detailed Company Law Recommendations ...... 12
Principle - By - Principle Review of Corporate Governance ...... 13 Section I: Ensuring The Basis For An Effective Corporate Governance Framework ...... 13 Section II: The Rights of Shareholders and Key Ownership Functions...... 17 Section III: The Equitable treatment of Shareholders ...... 22 Section IV: The Role of Stakeholders in Corporate Governance...... 25 Section V: Disclosure and Transparency ...... 26 Section VI: The Responsibilities of the Board ...... 30
Corporate Governance Assessment Ukraine
Country assessment: Ukraine This update of ROSC assessment of corporate governance in Ukraine benchmarks law and practice against the OECD Principles of Corporate Governance. The report focuses on publicly traded companies but is also relevant for other companies. Ukraine’s corporate governance environment has improved in recent years. Several developments have worked to enhance the portfolio investment climate: • High levels of economic growth (8.3 percent annual average over the five years to 2004) and high commodity prices have increased the demand for capital in Ukrainian industry. • Companies are reaching out to foreign (and domestic) capital by beginning the process of improving their corporate governance – at least three of the major financial–industrial groups have reportedly taken initiatives to become more transparent. Over 45 companies have issued depository receipts abroad. • A corporate governance code was issued in 2003, by a working group composed of the Securities and Stock Market State Commission (SSMSC) and many private sector groups; the code introduces international good practice to Ukraine. A number of private-sector and donor initiatives have continued to work to promulgate the code and improve practice at the company level. • Other reforms have been carried out including the passage of a new securities law (in March 2006) that strengthens the legal framework for the capital markets. However, many factors continue to impede reforms: • Company law is widely recognized to be inadequate and in need of reform. The current legal framework has facilitated a large number of corporate governance abuses including share dilution, asset stripping, and dubious transfer pricing. There have been many attempts to reform company law (most recently in February 2006) but all have been blocked in Parliament. • The large number of joint stock companies continues to pose a supervision challenge. • Despite many years of work, a recognized central depository has not been established. Market profile
Small but rapidly Ukraine’s equity market has grown rapidly during the bull market of 2002-2006. growing equity market Market capitalization at the end of September 2006 was UAH 178.6 billion (USD 35.4 billion), roughly a five-fold increase since the date of the last assessment in 2002. Market capitalization as a percent of GDP increased from 7.4 percent in 2002 to 30.6 percent of GDP in 2005. Ukraine’s market capitalization is now comparable to many of the (much smaller) EU accession countries. The top 10 companies in the market represented 56.7 percent of total market capitalization at the end of 2005. The turnover ratio was a low 0.8 percent in 2005, only about 1 percent of the OECD average.1
1 These figures are based on activity on the PFTS, the dominant securities trading market in Ukraine. The PFTS index is the only Ukrainian
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287 listed companies At the end of 2005, there were 287 companies listed on Ukraine’s largest trading including 9 blue chips; system, the PFTS, of which 9 “blue chips” were on the 1st tier, 20 on the 2nd tier 45 companies have and 258 on the 3rd tier.2 45 companies have issued global depository receipts issued depository overseas. receipts overseas Many thousands of There are two types of joint stock companies (JSC): open and closed. Only open additional companies joint stock companies may offer their shares through an open subscription (public have large numbers of offering) and have shares listed and traded on a stock exchange or OTC. shareholders In 2005, there were approximately 33,000 JSC registered in Ukraine, of which 11,000 were open JSC.3 These companies are a legacy of voucher privatization of the 1990s, and shares of most companies do not trade. Companies are not necessarily chartered in their most appropriate form (i.e. some closed companies are large and have many shareholders, and many open companies are small and have relatively few shareholders). Ownership is Because of the design of their privatization programs, most companies in Ukraine becoming more had a highly dispersed ownership structure in the early years of transition. Over concentrated time, ownership and control have become concentrated. Ukrainian industry has witnessed a major on-going struggle for control, as managers and foreign and local investors vied to obtain share packets large enough to control the operations of the company. Market participants report that this fight appears to be over in the majority of companies, and almost all companies have well-established controlling shareholders. Almost 15 million Despite the consolidation of control, the overall number of reported shareholder shareholder accounts accounts has not significantly declined during the consolidation of control – from 17 million in 2002 to almost 15 million today. This is perhaps due to share dilution and other practices, which concentrated ownership, but did not remove shareholders. Many individual shareholders are employees or former employees. Institutional investors are small players. Financial – industrial Ukraine's corporate sector is dominated by large business groups that began to groups dominate the assume their current structure at the end of the 1990s. The groups went through corporate sector several stages of development, starting with the untransparent “initial accumulation” phase of the early 1990s and then the establishment of formal and informal agreements among major corporations. The current structure consists of holding companies, which acquired businesses both through privatization and the purchase of contracts to manage and "lease" state owned enterprises. The largest five private sector groups (SCM, Industrial Union of Donbas, Privat Group, Interpipe, and MMW) have as many as 200 companies (including major banks and financial institutions) reducing transparency and minimizing taxes. • The biggest business groups control key sectors of the economy. They are concentrated in mining and metal production industries (9 groups) and oil and gas (3 groups). • Most of the large financial-industrial groups are so-called “industrial groups” (which at the center have management companies, serviced by group banks).
index recognized by international rating agencies. 2 PFTS was licensed as a stock exchange in June 2006. 3 Source: SSMSC. A 2005 IFC Corporate Governance Project Survey estimated that the total number of operating JSC was about 20,000, of which about 9,000 were open.
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In three groups (Privat, UkrSibBank and Finansy i Kredyt) big banks have traditionally been at the center of the group. • Most large groups are domestically owned. Only two of the largest 20 groups are controlled by foreign (Russian) capital (Smart Group and Lukoil). Some market participants report that certain groups are now beginning to understand the benefits of improved transparency and disclosure, and are hiring professional services firms to assist in the process of building systems for tax efficiency and compliance. The extent to which this represents the beginning of genuine reform remains to be seen. Securities legislation A number of decrees have been issued over the past few years that called for has improved but still measures to improve corporate governance, including upgrades of the legal has weaknesses framework and financial reporting standards, increased transparency of joint stock companies, improved provision of specialized education to the corporate sector stakeholders, and increased public awareness of corporate governance issues. A new law “On Securities” was passed in March 2006, which introduces prohibitions on insider trading and requires the disclosure of direct owners of 10% or more of the shares of publicly traded companies to the SSMSC, which is required to make the information public. While the revised securities legislation represents a major improvement over the prior law, the legal framework remains weak by comparison with the EU Directives, particularly on issues of transparency of ownership, the quality of financial reporting, and governance of collective investment funds. However the major The law “On Economic Companies” (1991) provides the basic framework for concern is that the joint stock company governance, as part of Ukraine's civil law system.4 Outside company law remains observers (and the principle-by-principle assessment) generally agree that the inadequate existing company law is vague and does not adequately support many basic shareholder rights. Various draft laws to address the weaknesses have been prepared but were rejected by Parliament. Delay of company law reform appears to be driven by business interests who oppose provisions for additional transparency and other governance requirements.
A voluntary corporate The 2003 Corporate Governance Code (Principles of Corporate Governance of governance code has Ukraine) adapted the OECD Principles and many modern corporate governance been adopted practices to Ukraine. The Principles are aimed at open joint stock companies with traded shares. According to a recent IFC survey, board members in 30% of companies surveyed have a “fairly deep knowledge” of the Corporate Governance Principles and almost 50% board members have a “basic knowledge”. 13.2% of companies surveyed are ready to disclose complete information on their compliance with the standards established by the Principles.5 In any case, the Principles are strictly voluntary and listed companies are not required to prepare an annual "comply or explain" public disclosure statement. Key issues
The following sections highlight the principle-by-principle assessment of Ukraine’s compliance with the OECD Principles of Corporate Governance.
4 A new Civil Code was introduced in 2004 and includes a number of important corporate governance provisions. 5 See Survey of Corporate Governance Practices in Ukraine 2004, IFC Ukraine Corporate Development Project, 2006
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Investor protection
Weaknesses in the Existing company law is recognized to be inadequate. The principle-by-principle company law have assessment highlights the absence of shareholder approval requirements for large resulted in many asset sales, related party transactions, and new share issues. In addition specific corporate governance rules for the conduct of general meetings of shareholders are missing. abuses over the past The inadequate legal framework has resulted in a large number of major corporate 10 years abuses and important violations of shareholder rights. Dilution of share capital, asset stripping, and transfer pricing, all damage investor rights and confidence in the stock markets. Vagueness in the existing law has provided opportunities for corporate governance abuses by management and controlling shareholders. The number of abuses While difficult to confirm, market participants note that the number of abuses has appears to have declined in recent years. This is due to increased awareness of corporate decreased governance, but more importantly the end of the struggle for corporate control of much of the business sector. Share registration Shareholder recordkeeping remains generally slow and expensive (especially for remains problematic frequently traded issues), difficult to regulate (because of the large number of licensed registrars), and not conducive to minimum degrees of transparency of ownership (because of frequent use of nominees and other intermediaries). A more recent problem is the existence of “dual” registrars.6 The lack of a The current system functions (if imperfectly) at current volumes but does not domestically and meet international standards. To date, the drive to create a unified central internationally depository has stalled. Problems include unresolved political conflicts among recognized central several different institutions and issues related to governance and ownership. depository has slowed Most market participants continue to prefer to settle off-shore, to avoid difficult capital markets foreign exchange regulations. A single central depository (with an integrated cash development settlement mechanism) should be created for equities, and additional technical assistance provided to bring it to international standards. The governance of Many corporate governance violations appear to occur in the over 1,000 State-owned companies with State ownership stakes. In many cases, State-appointed board enterprises remains a members have reportedly acted against the interests of the company and other concern shareholders. In addition, the law sometimes requires companies to treat the State differently than other shareholders, or to act against their commercial interest. For example, companies are legally obligated to pay dividends to the State within 30 days, while there is no corresponding obligation for other shareholders. A more recent issue relates to changes to procurement rules, which inhibit state-owned companies from choosing the lowest cost suppliers—and may eventually impede the privatization of the companies.
Disclosure
Disclosure of There are no legal requirements for Ukrainian companies (or shareholders) to ownership and control declare their ultimate ownership and control structures. While nominal remains problematic shareholdings must be disclosed, the common uses of privately held companies or offshore intermediaries renders control structures virtually opaque. There is no requirement for the (nominal) shareholder list to be disclosed at the time of the
6 In up to 15 cases; disputes between shareholders have resulted in one side arranging court rulings that have transferred share registries to another registrar (where the registry is reportedly “cleansed”). Following the transfer, the company effectively has two different registries with two different lists of shareholders.
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general meeting of shareholders.
An electronic company An electronic company register has been created and includes important basic registrar has been information about companies (i.e. company charters and names of board created members). However implementation is in an early stage and market participants report that its influence is so far minimal. In order to increase transparency of the business sector, the register should be made easily accessible to the public.
Compliance with The law requires companies to provide shareholders with basic information, and disclosure to file annual reports to the SSMSC. All 20,000 joint stock companies are requirements has required to file annual financial statements with the SSMSC. In a 2005 IFC improved, but survey, almost all companies surveyed claimed to fulfill their legal requirements timeliness, availability, to provide financial information, and market participants confirm that annual and quality remain key reports are produced for most large companies traded in the market. However, issues timeliness and availability generally remain a problem, and quality varies widely. Since 2002, the SSMSC has sponsored a competition for the best periodic reporting.
Annual report Annual report requirements are now under revision, because the implementing requirements are regulations for the new Securities Law have not yet been issued. Regulations under revision issued under the old law did not meet the non-financial disclosure requirements outlined in the OECD Principles although the voluntary Principles of Corporate Governance do require a high level of disclosure, including conflicts of interest and related party transactions.
Financial reporting Ukrainian accounting standards are gradually moving towards international appears to be slowly accounting standards. The SSMSC has issued decrees which ordered listed JSCs moving towards to transition to International Accounting Standards in 2003. However, these international decrees have been challenged in court and are not considered to be binding. The standards SSMSC oversees JSC disclosure, but has limited resources and does not review financial statements specifically for compliance with either NSA or IFRS. The Accounting and Auditing ROSC (forthcoming) reviews in detail issues related to financial reporting standards.
Company oversight and the board
The legal framework Ukraine has a two-tier board structure, including a supervisory board, a establishing the duties management board, plus an auditing (or “revision”) commission. All three bodies and responsibilities of are elected by shareholders, but the vagueness of the company law provides little the boards of directors description of their roles and responsibilities. Supervisory board members are not is inadequate obliged to conduct their duties with due care or diligence or in the best interests of the company. Loopholes in the law can allow an extraordinary delegation of power to management. There is little detail on the role and responsibilities of the two boards, and companies are obliged to lay out the roles and authorities for supervisory boards as part of the company charters. The Principles include The Ukraine Corporate Governance Principles address fiduciary duties and good practice supervisory board responsibilities (including responsibilities for managing recommendations on conflicts of interest and overseeing internal controls), and establish clear board supervisory boards responsibilities and functions. In addition, the Securities Commission has adopted a Model Charter and bylaws for open JSCs. The model company documents are also based on international best practices, including clear provisions on supervisory and management boards. The Principles are carefully drafted and represent an important advance. However the Principles are voluntary and cannot substitute for weaknesses in
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company law.
Enforcement
The SSMSC is the The principal government agency responsible for regulation of the securities main regulator of market is the Securities and Stock Market State Commission (SSMSC), which securities market and was set up in 1995. The SSMSC has broad powers to issue rules and regulations, corporate governance impose fines (of up to UAH 170,000), and issue injunctive orders to remedy a regulation violation. The SSMSC conducts thousands of investigations each year and regularly uses it various powers. Changes to the securities legislation ensure that the Chairman of the SSMSC is hired and fired by the President of Ukraine in coordination with the Parliament (Verkhovna Rada), providing some increased independence for the SSMSC. However, legal uncertainties have traditionally inhibited the ability of the SSMSC to actively wield its powers. The level of fines that can be assessed is relatively low. The large number of The mandate of the Securities and Stock Market State Commission (SSMSC) joint stock companies covers a broad spectrum of companies, from large, listed companies with many continues to pose a shareholders, to small closed joint-stock companies with only a few shareholders. supervision challenge Keeping track of this large number of companies dilutes the SSMSC’s focus effectiveness. Recommendations
The following policy recommendations are broken down into recommended changes to legislation, institution building, and private sector initiatives, and are further categorized into immediate, medium term (1-2 years) and long term (3-5 years). Recommendations related to accounting and auditing standards and other financial reporting questions are included in the forthcoming Accounting and Auditing ROSC.
Legislative changes
Immediate Disseminate the Corporate Governance ROSC and conduct public workshops to discuss its findings and recommendations. Develop an action plan to implement the agreed recommendations of the ROSC. The action plan should include a phased-in program to address the issues raised by the ROSC, particularly on discrepancies between current Ukrainian legislation and the EU Directives. Clarify the legal framework by adopting the draft Law "On Acknowledgement as Invalid of Some Laws of Ukraine Due to Adoption of the Civil Code of Ukraine". The draft law removes contradictions between the Civil Code, Commercial Code and other legislation. Implement the new Law on Securities. Priority should be given to implementing the disclosure requirements for listed companies and the new rules for insider trading. Medium term Improve ownership disclosure. Require public disclosure of ownership by shareholders who control, directly or indirectly, 5% or more of a JSC through changes to relevant legislation and regulation. Indirect ownership should be defined in the law, along the lines suggested in the EU Transparency Directive. Reform the company law. The company law should be revised to strengthen the roles and responsibilities of supervisory boards (and establish statutory fiduciary duties) and require approval of the shareholders' meeting for large asset sales and
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issuance of new equity. It would be helpful if a donor-coordination group could be created to build consensus among the donors and advise the SSMSC on the key provisions of a company law. The SSMSC has a Special Task Force on Corporate Governance that includes representatives of a number of donor supported projects and could be revived for this purpose. Introduce a Law on Conglomerates that would apply to all financial-industrial groups, whether they include state-owned companies or not. The Law on Conglomerates should follow the EU Conglomerates Directive and require that a lead supervisor be established for financial institutions that are part of financial or mixed financial-industrial conglomerates. The Directive also requires that special thresholds be set for related-party transactions among companies and financial institutions within the same conglomerate. Long term Review the Law on Collective Investment Funds for compliance with EU standards. The law should provide for the levels of investor protection seen in the EU's Directive on Undertakings for the Collective Investment of Transferable Securities (UCITS). Introduce regulation of takeovers and the market for corporate control. The law should protect the rights of shareholders during changes in control and brings Ukrainian practice closer to the European Union Takeover Directive. The law should also include a mandatory tender rule that would require a shareholder who purchased a significant stake in the company (e.g. 33 percent) to make an offer to all other shareholders at a fair, market based price. The new law, or related legislation, should introduce rules for acting in concert that govern shareholder and others working together to take control of company or prevent a change in control. A squeeze out provision that allows shareholders with 90% or greater ownership to make a binding offer to other shareholders at a fair, market based price, should also be considered. Many of these provisions are included in the draft JSC law. Introduce the disclosure of corporate governance policies, share voting policies, and material conflicts of interest by institutional investors. Institutional investors should be required to disclose their voting in the GMS and develop and disclose policies on how there ownership will be exercised. Licensed professionals and firms active in securities trading (as defined in the law) should be required to provide honest and accurate information to clients and the public. Custodians should be required to seek voting instructions from their clients, including foreign shareholders with GDRs. To facilitate this process, training should be provided for relevant financial market participants, including investment fund managers and staff. Leading banks, funds, and brokers should be encouraged to adopt these practices voluntarily.
Institutional Strengthening
Immediate The SSMSC should focus its enforcement efforts. Priority should be given to publicly traded companies and other open JSCs with large numbers of shareholders. The authorities should consider modifying law and regulation to lower the reporting requirements for smaller companies that are now required to report. This should include dropping the quarterly reporting requirement for small joint stock companies and possibly the annual reporting requirement for very small ones. The commission would also benefit from a dedicated and independent source of
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finance and less dependence on annual budgetary allocations. All the financial supervisors should be strengthened in their ability to monitor financial institutions. Future work on supervisory strategy and implementation of risk-based supervision should focus on the ability of financial supervisors to monitor related-party transactions within mixed industrial-financial conglomerates. The roll-out of the new business registry should be completed. The State Committee of Ukraine for Regulatory Policy and Entrepreneurship should work to ensure that the new system allows for electronic access by shareholders and other members of the public to company information, including company charters and the list of company founders. Enforcement of existing disclosure requirements, including reporting of related party transactions, should be enhanced for publicly traded companies. While the Chamber of Auditors oversees audit, clear responsibility should be assigned to the SSMSC for the quality of reporting by listed companies, including compliance with relevant accounting standards, and needed training provided to develop SSMSC’s capacity in this area. Special attention should be given to NAS/IAS 24, which covers disclosure of related party transactions. Ukraine should build on the reform efforts of the State Property Fund and develop an ownership policy for companies with state capital consistent with the 2005 OECD Guidelines on Corporate Governance of State Owned Enterprises that separates the exercise of the state’s ownership rights from other regulatory functions. While only a few SOEs have minority shareholdings, the Government may wish to consider IPOs of minority shareholding positions as one of the options for partial privatization of SOEs. An SOE diagnostic based on the Guidelines should be carried out to address the specific challenges of the state owned sector. Governance diagnostics should be prepared for the other major parts of the financial sector, including collective investment funds, private pension funds, banks and insurance. Medium Priority The government (in partnership as much as possible with the private sector) should move to rapidly identify a model for future development of a central depository. Implementation should be left as much as possible to the private sector. The central depository is an important corporate governance institution, and the absence of an internationally-recognized central depository has hindered the development of the equity market and ownership transparency. Following the development of the model (which could include state ownership) implementation should be left to the private sector, with a minimum of political interference. Staff and resources that have been carefully developed and built at the MFS (and who have the trust of the market participants) should evolve into the core of the new institution. The model for the future development of the central depository system should include higher requirements for share registries (for example, through a central share registry) and a shareholder approval requirement on registry transfer should be imposed. Capital and other requirements should be increased to force a consolidation of the registrar industry. To work to solve the problem of dual registries, the transfer of company registries should require shareholder approval, and there should be a 90 day waiting period. Court procedures should be modified to restrict the number of courts that can rule on the validity of company registries, by adopting the draft Law of Ukraine «On October 2006 Page 8 Corporate Governance Assessment Ukraine
Introduction of Amendments to Some Laws of Ukraine Relative to Demarcation of Cases within the Jurisdiction of Commercial Courts and the Courts of General Jurisdiction (registration №2279) ». Move more funds settlement on-shore. Market participants in Ukraine are united in their view that the single most important step to strengthen the capital market (and increase market transparency and allow the development of a real central depository) is to modernize the foreign exchange rules for non-bank financial institutions. Difficulties in obtaining foreign exchange are one of the key reasons why market participants (especially foreign market participants) prefer to settle off-shore, in foreign currency. This works against the MFS (and any central depository) because it makes its core product (delivery versus payment settlement, in local currency) less attractive. Solutions to this problem would require the involvement of the central bank (which should also work to facilitate a modern local currency settlement facility at the central depository). In order to enable the judicial system to deal more effectively with shareholder and corporate litigation, a comprehensive effort to standardize court practice should be undertaken, specialized training should be provided for judges, and corporate actions should be referred to commercial courts, where judges tend to be able to deal with them more competently. Mediation and other forms of alternative dispute resolution (ADR) between companies and shareholders should also be explored. Longer term Strengthen auditor independence and accountability by implementing the Chambers review requirements for audits, focusing first on listed companies. Auditor independence would also be strengthened by specifying in the law that the GMS should choose the external auditor with guidance from the supervisory board, and that the auditor has a duty, and liability, to the company and its shareholders. Work with the private sector to develop a more streamlined process for disseminating company information. The current process for reporting should be streamlined for listed companies to allow direct and immediate online posting of company reporting, including financial, non-financial, and ad-hoc reporting. This will require significantly reducing the time between when information is provided to the SSMSC and passed on to public.
Private sector initiatives
Medium Priority The PFTS should enhance the listing requirements for its top tier companies, including the full adoption of IFRS and a requirement to "comply or explain" non-compliance with the Ukraine Corporate Governance Principles. Corporate governance can be improved by regulation (by imposing requirements on companies to introduce better practice), but also by providing incentives to companies to voluntarily adopt higher standards. Ukraine's capital market is now at the stage where the need to attract patient and long-term capital can successfully encourage companies to move towards international best practice. To facilitate this process and allow companies to differentiate themselves, the PFTS (now that it is licensed and recognized as a central element of Ukraine's capital market framework) should introduce a new listing tier with significantly higher standards. These standards should include a requirement for listed companies to "comply and explain" their adherence to the Corporate Governance Principles, and adoption of full IFRS. This incentive cannot be expected to result in a quick payoff. However, no action in this area will result in more and more companies listing abroad in order to clearly identify themselves as October 2006 Page 9 Corporate Governance Assessment Ukraine
corporate governance leaders. An Institute of Corporate Governance should be created to provide training to board members and other company officers. The institute could build on IFC’s successful work in this area as well as that of NGOs and other donor-sponsored initiatives on corporate governance.
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Summary of Observance of OECD Corporate Governance Principles
Principle O LO PO MO NO Comment I. ENSURING THE BASIS FOR AN EFFECTIVE CORPORATE GOVERNANCE FRAMEWORK IA Overall corporate governance framework X • Key reform has been delayed IB Legal framework enforceable /transparent. X • Legal framework contain gaps and contradictions IC Clear division of regulatory responsibilities. X • SSMSC main capital market regulator ID Regulatory authority, integrity, resources. X • SSMSC oversees ten of thousands of companies II. THE RIGHTS OF SHAREHOLDERS AND KEY OWNERSHIP FUNCTIONS IIA Basic shareholder rights X • Basic shareholder rights remain weak. IIB Rights to part. in fundamental decisions. X • Capital increases abused. IIC Shareholders AGM rights X • Problems with registration, notification, conduct IID Disproportionate control disclosure X • Ownership disclosure poor. IIE Control arrangements allowed to function. X • Little shareholder protection during control changes. IIF Exercise of ownership rights facilitated. X • Institutional investors do not disclose GMS voting. IIG Shareholders allowed to consult each other. X • No legal concept of “acting in concert” III. EQUITABLE TREATMENT OF SHAREHOLDERS IIIA All shareholders should be treated equally X • Minority redress limited. IIIB Prohibit insider trading X • New securities law prohibits insider trading. IIIC Board/Mgrs. disclose interests X • Law does not regulate conflicts of interest. IV. ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE IVA Legal rights of stakeholders respected. X • Union reps. can participate on the supervisory board. IVB Redress for violation of rights X • Redress mandated by constitution, but courts weak. IVC Performance-enhancing mechanisms X • Shares can be used as compensation. IVD Access to information X • Rights to information not always respected. IVE “Whistleblower” protection X • No explicit whistleblower protection. IVF Creditor rights law and enforcement X • Basic rights in place, limited information on borrowers. V. DISCLOSURE AND TRANSPARENCY VA Disclosure standards X • All JSCs required to file annual report, quality low. VB Standards of accounting & audit X • Companies with foreign investment use IFRS. VC Independent audit annually X • ISA implemented 2003, only used by big four firms. VD External auditors should be accountable X • Law unclear on auditor accountability and liability. VE Fair & timely dissemination X • Multiple info channels, availability still limited. VF Research conflicts of interests X • Legal requirements minimal. VI. RESPONSIBILITIES OF THE BOARD VIA Acts with due diligence, care X • LC does not have duties of care or loyalty. VIB Treat all shareholders fairly X • No barriers to preferential treatment. VIC Apply high ethical standards X • Limited application ethics / stakeholder involvement. VID The board should fulfill certain key functions X • Few specific board responsibilities. VIE Exercise objective judgment X • Two tier board, no independence requirements. VIF Access to information X • No specific provisions on access to information.
Note: O=Observed, LO= Largely Observed, PO= Partially Observed, MO= Materially Not Observed, NO=Not Observed
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Detailed Company Law Recommendations
The new company law should: o Be clear, internally consistent, and harmonized with existing legislation; o Clarify the distinctions between open and closed joint stock companies. It should not allow the creation of new closed companies with more than 100 shareholders and should not restrict the rights of closed company shareholders to resale their shares; o Provide clear rules for the transition of existing open and closed joint stock companies to the company forms specified in the new law. These rules should protect minority shareholders. The Board o Specify board member duties to act reasonably, in the interest of the company and all shareholders, and with due care and diligence (like a “reasonable man conducting his own affairs”); and their liability to the company for violating those duties; o Specify the exclusive powers of the supervisory board, including oversight of company strategy, governance and management, internal controls, and disclosure; o Include rules to manage conflict of interest involving board members; o Specify that members of the executive board and management cannot serve on the supervisory board; o Specify the right of supervisory board members to access information and documents of the company that are necessary for making well-informed decisions and for performing their duties; o Remove the revision commission for open/public companies, and instead require an audit committee consisting of members of the supervisory board; o Allow certain companies to have a one person “executive board” chosen by the supervisory board; o Give the supervisory board exclusive power to appoint the members of the executive board. The General Meeting of Shareholders o Specify procedures on notifying shareholders before the GMS, including information on the agenda; o Specify procedures governing the GMS that ensure fair treatment of shareholders, including those represented by proxies, building on the Ukrainian Principles of Corporate Governance. The law should allow for questions and discussion under reasonable circumstances and the list of institutions authorized to certify proxy forms should be expanded; o Allow for a second GMS with lower quorum requirements in open and or listed companies if quorum requirements are not initially met; o Specify the exclusive power of the GMS to approve supervisory board member remuneration, and mandatory disclosure of supervisory board member and executive remuneration to shareholders. Other Shareholder Rights o Contain clearer rules on capital increases and pre-emptive rights that protect shareholder rights; o Specify rules on changing corporate form that protect shareholder rights; o Specify the right for shareholders to call an extraordinary meeting that cannot be delayed by management; o Include the right for shareholders to approve major transactions, and a minimum threshold for exercising that right; o Include the right for shareholders to be informed of conflicts of interest involving board members and major corporate decisions; o Specify the right of shareholders to sale their shares to the company at a market based price when they dissent from certain major transactions and other major corporate events; o Specify the right of shareholders to have access to specific company information; o Specify circumstances under which shareholders may file suits against board members and company officers for violating their duties to the company; o Allow for proportional representation on the supervisory board to facilitate the representation of minority shareholders.
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Principle - By - Principle Review of Corporate Governance This section assesses Ukraine’s compliance with each of the OECD Principles of Corporate Governance. Policy recommendations may be offered if a Principle is less than fully observed. Observed means that all essential criteria are met without significant deficiencies. Largely observed means only minor shortcomings are observed, which do not raise questions about the authorities’ ability and intent to achieve full observance in the short term. Partially observed means that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. Materially not observed means that, despite progress, shortcomings are sufficient to raise doubts about the authorities’ ability to achieve observance. Not observed means no substantive progress toward observance has been achieved.
SECTION I: ENSURING THE BASIS FOR AN EFFECTIVE CORPORATE GOVERNANCE FRAMEWORK The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.
Principle IA: The corporate governance framework should be developed with a view to its impact on overall economic performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets. Assessment: Materially not observed
Capital markets. Ukraine’s equity market has grown rapidly during the bull market of 2002-2005. Market capitalization at the end of 2005 was 178.6 billion (USD 35.4 billion), roughly an eight-fold increase since the date of the last assessment in 2002.7 Market capitalization as a percent of GDP increased from 7.4 percent of GDP in 2002 to 30.6 percent of GDP in 2005. Ukraine’s market capitalization is now comparable to many of the (much smaller) EU accession countries. The top 10 companies in the market represented 56.7 percent of total market capitalization at the end of 2005. The turnover ratio was a low 0.8 percent in 2005, only about 1 percent of the OECD average. Ukraine and other Emerging Markets: Selected Market Data (2005) Market Cap Market Cap Turnover ratio Market Cap % Market Cap Turnover Country Name (% GDP) % of ($US mill) % % of OECD GDP* ($US bill) Ratio (%) OECD Avg. of OECD Avg. Avg. Ukraine 30.6 25.0 0.8 30.8 1.7 0.8 Russia 71.8 548.6 3.3 72.2 36.5 3.4 Poland 31.4 93.9 3.0 31.6 6.3 3.1 Czech Republic 31.3 38.3 5.4 31.5 2.6 5.6 Hungary 29.8 32.6 7.6 30.0 2.2 7.9 Romania 20.9 20.6 1.6 21.0 1.4 1.7 Slovak Republic 9.5 4.4 0.1 9.6 0.3 0.1 Latvia 16.0 2.5 0.3 16.1 0.2 0.3 OECD Average 99.4 1,501.4 95.7 100.0 100.0 100.0 * Source: WDI Indicators online (September 2006). At the end of 2005, 287 companies were listed on the First Stock Trading System (the “PFTS”), the dominant securities trading market in Ukraine, and accounted for 86 percent of the aggregate turnover on the organized market in 2005.8 This included 9 “blue chips” listed on the 1st tier, 20 on the 2nd tier and 258 on the 3rd tier. The vast majority (over 90 percent) of securities transactions are settled directly at the registrar (off-exchange), 45 companies have issued global depository receipts overseas. Ownership framework. While the shares of many privatized companies have been bought up and consolidated by managers, financial intermediaries and strategic investors; most Ukrainian companies still have many small shareholders, including employee shareholders who were granted a preferential right to acquire shares early in the privatization process. There are millions of shareholders in Ukraine, and almost 15 million shareholder accounts.9 However anecdotal evidence suggests that the actual consolidation in most companies is much greater than the overall figure would indicate. The following table reports old data on the shareholder structure by number of shareholders. According to the 2005 IFC Survey,
7 Market capitalization is determined based on companies listed on the PFTS 8 In 2003, there were eight stock exchanges and two OTCs licensed in Ukraine, of which only the PFTS and the Ukrainian Inter-Bank Currency Exchange (the “UICE”) have regular trading sessions. The UICE was initially established as a currency exchange and opened a securities trading floor in 1997. However, the UICE handles mostly primary placements of securities issued by the State Property Fund during privatization, where secondary trading in shares is rare. 9 Source: SSMSC This figure represents the number of accounts in registrars, and includes the double counting caused by individuals and institutions holding shares in more than one company.
October 2006 Page 13 Corporate Governance Assessment Ukraine open JSCs had on average 1192 shareholders, compared to 65 for closed JSCs. Many leading companies belong to financial–industrial groups. Anecdotal reports suggest that six oligarchs have assembled holding, each with as many as 200 companies and at least one major bank. Foreign ownership is growing. The SSMSC estimates that foreigners own 10 percent or more of approximately one thousand companies. Institutional Investors. The Ukrainian investment industry is represented mostly by investment funds that were created during mass privatization. At the end of 2005, there were 134 asset management companies and 221 investment funds in Ukraine operating under the legal framework established in 2001.10 In addition there are 48 private pension funds with approximately UAH 21 million in assets and 40,000 members. Local banks, except those representing major financial and industrial groups, have moderate ownership stakes in Ukraine’s corporate sector. Insurance companies do not play a significant role in institutional investment activities. The Ukrainian investment industry is dominated by investment funds created under the Law of Ukraine “On Collective Investment Funds”. As of July 1, 2006, 464 collective investment funds were registered in the Integrated Public Register of Collective Investment Funds, and had issued securities worth approximately UAH 42.9 billion.11 34 asset management companies have been licensed to manage the assets of collective investments. In addition, there are 67 non-governmental pension funds, including 51 open funds, 10 corporate funds and 6 professional non-governmental pension funds. Total assets of the non-governmental pension funds are estimated to be UAH 94.7 million. Number of Reporting Joint Stock Companies by Number of Shareholders, end of 2001
Num. of shareholders Open Closed Total More than 50,000 12 12 49,999 – 10,000 145 145 9,999 – 5,000 272 5812 330 4,999 – 1,000 1,632 261 1,893 999 – 500 1,549 338 1,887 499 – 100 3,981 1,046 5,027 Less than 100 2,253 5,964 8,217 Total Companies 9,844 7,667 17,511 Total Shareholders: 11,888,959 4,845,457 16,734,416 * Source: SSMSC. Note that the total number of reporting companies is smaller than the total number of companies because of non-compliance with reporting requirements. State-Owned Enterprises. The State holds shares in more than 1500 companies, including significant or controlling blocks of shares (i.e., 25 percent or 50 percent plus one share) in companies having strategic significance for the economy and security of the State. Market participants note that corporate governance violations have occurred in companies with large State ownership. The government’s interests may not be well represented by its nominated members of the board, who may have been appointed by a different governmental organization than the company’s statutory owner. In addition, the State often ignores the corporate governance machinery and bypasses the board to obtain desired results. The State may also require high levels of dividend payments from companies with majority State participation. In recent years the State Property Fund has encouraged SOE board members to receive director training and taken other steps to improve SOE governance. In the 2005 IFC Survey, only 34.5% of the board members of state-owned JSCs assessed their corporate governance practices as “good” or “excellent”; compared to 62.1% of board members of private sector companies.
Principle IB. The legal and regulatory requirements that affect corporate governance practices in a jurisdiction should be consistent with the rule of law, transparent and enforceable.
Assessment: Materially not observed
Corporate legal framework. The Laws on Economic Companies (LC) was adopted in 1991 and has been amended 20 times, most recently in 2005. Regulators and market participants do not believe it provides an adequate framework for corporate governance. There have been a number of attempts to adopt a new company law, but none have received final approval in the Parliament. In 2002 the President and in 2003 the Cabinet of Ministers issued decrees that called for measures to improve corporate governance in joint stock companies. However subsequent court decisions limited their implementation. Revised Civil and Commercial Codes were introduced on January 1, 2004, and also contain important—and
10 As stipulated by the new Law “On Institutions of Mutual Investment” adopted March 15, 2001. 11 Investment funds set up under the old legal framework were required to either liquidate their activities or come into compliance with the new Law, within two years of the Law entering into force. As for October 01, 2006, 52 investment funds and 85 mutual funds of investment companies set up under the old legal framework had been liquidated. As for July 1, 2006, seven investment funds and six investment companies had been reorganized into collective investment funds, and five mutual funds and investment companies were on the way. 12 The SSMSC reported 58 closed-end companies with “more than 5,000” shareholders.
October 2006 Page 14 Corporate Governance Assessment Ukraine according to market participants—contradictory provisions on JSCs. Company types. The LC provides for five corporate forms, of which only the joint stock company may issue shares. There are two types of JSCs: open and closed. Only open joint stock companies may offer their shares through a public offering and have shares listed and traded on a stock exchange or OTC. There are approximately 33,000 joint stock companies incorporated in Ukraine, however only 20,000 of those are believed to be operational13. This includes approximately 9,000 open joint stock companies. Many large companies with tens of thousands of shareholders were privatized as “closed” JSCs, and many “open” companies are quite small. Securities law framework. The Law of Ukraine "On Securities" became effective on May 12, 2006.14 The new law contains provisions on stock markets, the range of securities that can be issued, and professional market participants. It describes how shares should be issued, the requirements for the prospectus, and mandates registration of new issues with the SSMSC for both public and private placements. It includes annual and quarterly reporting requirements for issuers, rules for reporting “special ” information, and introduces rules on insider information and insider trading, which were not previously defined or restricted. While the revised securities legislation represents a major improvement over the prior law, the securities legal framework does not appear to comply with EU Directives, particularly on issues of transparency of ownership, the quality of financial reporting, and collective investment funds. Many of the provisions of the law will require secondary regulation issued by the SSMSC to be fully implemented. Listing rules. Listing rules are currently minimal. The SSMSC has set minimum listing requirements which apply only to the stock exchanges—not the PFTS—and are met by only a handful of companies. The PFTS has three tiers of listed companies. Companies listing on the first and second tiers must meet minimum capital requirements, have a certain level of monthly trading, and provide quarterly financial reports and audited annual reports. Companies trading on the third tier must only follow other legal requirements, including registration at the SSMSC. Listing requests can be submitted by brokers; Listing brokers must be willing to make a market in the shares for a certain period of time (10 business days for tier III, 30 for tier II, and 100 days for tier III). The PFTS also sets requirements for corporate bonds and the shares of investment funds. Banking Law. The Law on Banks and Banking and the Law on the National Bank of Ukraine (NBU) were adopted in 2000 and 1999, respectively. Banks also come under the relevant provisions of the LC. As noted below, the NBU regulates certain aspects of bank corporate governance, and bank board members have to meet stricter eligibility requirements than board members for other companies. Codes. The SSMSC has promulgated voluntary Principles of Corporate Governance of Ukraine (Principles). Intended primarily for open JSCs with publicly traded shares, the Principles do not form part of listing requirements, and there are no requirements to “comply or explain”. The Principles were developed in 2003 and follow the OECD Principles and many modern corporate governance practices. The Principles have been fairly well absorbed by the board members of Ukrainian companies: according to the 2005 IFC Survey, board members in 30% of companies surveyed have a “fairly deep knowledge” of the Corporate Governance Principles; and almost 50% board members have a “basic knowledge”. 13.2% of companies surveyed are ready to disclose complete information on their compliance with the standards established by the Principles. The SSMSC has also promoted the development of a model charter and bylaws for open JSC, based on the Principles, Ukrainian legislation, and international best practices. A number of companies have adopted the model charter.
Principle IC. The division of responsibilities among different authorities in a jurisdiction should be clearly articulated and ensure that the public interest is served.
Assessment: Partially observed
There is limited overlap in the responsibilities of the financial regulators and the self-regulatory organizations. No regulator or government agency is clearly responsible for compliance with the LC. Securities regulator. The principal government agency responsible for regulation of the securities market is the State Commission on Securities and Stock Market (SSMSC), established in 1995. The SSMSC has broad powers to issue rules and regulations regarding the operation of the securities market; to regulate and monitor the issuance and circulation of securities; to license, regulate and supervise stock exchanges and professional stock market participants; and to monitor enforcement of securities laws and regulations. The SSMSC oversees the disclosure of securities issuers, including both closed and open JSCs. Stock exchange. At the end of 2005, there were eight stock exchanges and two OTCs licensed in Ukraine. Technically an OTC, the PFTS accounts for more than 88 percent of trading volume and includes two tiers for companies that meet listing requirements. The PFTS has been working for some time to become licensed as a stock exchange; the new Securities Law should remove a legal constraint and allow the licensing to proceed. The other exchanges are largely dormant, subsisting on trading in commodities and options and participation in privatization. The PFTS is a licensed self-regulatory organization owned by its approximately 300 members. In the event of non-compliance with its rules and procedures, the PFTS may impose sanctions upon its members, including written warnings, fines of up to 20,000 UH, temporary suspension, temporary
13 IFC Survey 14 This law replaced a law originally enacted in 1991.
October 2006 Page 15 Corporate Governance Assessment Ukraine bans on access to the trading system, or cancellation of members’ qualification certificates. The PFTS can also de-list securities in the event of a breach of listing requirements or on other grounds, such as liquidation of the issuer. The PFTS maintains the IStock website, which has information on over 14,000 issuers. The PFTS index is the only Ukrainian index recognized by international rating agencies. Central depository. There are three different depository institutions in Ukraine. The “Inter-Regional Stock Union” (Mezhregionalny Fondoviy Soyuz, or MFS) carries out many of the functions of a central depository for shares and corporate bonds. MFS was established by market participants in 1997 with assistance from USAID, and provides transactions executed on securities exchanges (primarily the PFTS). It also offers registration services directly to issuers, and currently acts as a registry for almost 17% of dematerialized securities. The National Depository of Ukraine (NDU) was established in May 1999 and is 86% government-owned. The NDU has traditionally performed various activities related to securities settlement (e.g. setting ISIN numbers for Ukraine) but has not performed clearing and settlement for market participants.15 However, a number of recent steps have been taken by the government to remove these restrictions, and market participants now view NDU as a direct competitor to MFS. The Depository of State Securities, was established in 1999 by the National Bank of Ukraine to facilitate registration and clearing of transactions of government securities between the Ministry of Finance of Ukraine and commercial banks. National Bank of Ukraine operates as an agent of the Ministry of Finance in clearing and settlement. The governance of both the MFS and the NDU has raised concerns among market participants, regulators, and donor institutions. MFS is considered by market participants to be well-managed, responsive to customers, and continuously working to improve its operations. However, it was the target of a takeover attempt in 2004 by two competing private business groups, with Pryvatbank Group acquiring at least 28% of shares (through several financial entities).16 The resulting ownership structure has raised the possibility that its operations would be captured by business groups, resulting in a loss of independence and trust. NDU, on the other hand, is seen by market participants as a “political” solution, with few connections to the market and with no experience in processing transactions. In addition, the SSMSC votes the shares of the government, creating a conflict of interest between its role as regulator and owner.17 On November 24, 2005, the President of Ukraine issued a decree outlining a number of reforms in the financial sector, including a proposal for the development of NDU as a fully functioning depository (including control of all shareholder recordkeeping, in the form of a central registry). Banking and other regulators. The National Bank of the Ukraine (NBU) is the banking regulator. Under the law, banks may invest in the shares of other companies provided they obtain prior written approval of the National Bank of Ukraine. Prior approval of the National Bank is also required for acquisition (directly or indirectly) of 10, 25, 50 and 75% of the share capital or voting rights in a bank. The NBU requires banks to comply with international standards of accounting and auditing. Company Registrar. In 2004 a new Law on Company Registration came into effect, new offices for the State Registrar are being opened, and a new electronic registry is being launched. Under the new system information on company founders, company charters, and other basic information should be readily available for a fee. In practice, market participants still tend to get such information directly from the company, if at all.
Principle ID. Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources to fulfill their duties in a professional and objective manner. Moreover, their rulings should be timely, transparent and fully explained.
Assessment: Partially observed
Authority, integrity and resources of regulators. The SSMSC licenses broker/dealers, registrars, custodians (“keepers”), asset management companies, and the depositories and stock exchanges. For issuers, the SSMSC oversees disclosure— all JSCs, including closed ones, are supposed to file with the commission—and registers issuances and related information (the prospectus). They enforce the securities law and related legislation. This includes the power to issue warnings, suspend the placement or circulation of securities, suspend or withdraw licenses, impose fines of up to 170,000 UH, and issue injunctive orders to remedy a violation. The SSMSC conducts thousands of investigations each year and regularly uses it various powers. However the number of enforcement actions is limited given the very large number of JSCs and other market participants it oversees. The SSMSC can and does issue implementing regulation and actively participates in the drafting and amending of legislation.
15 A Presidential Decree of December 1999 (and a Memorandum of Understanding between the Government, NBU, SEC, USAID and the World Bank that was signed in 1999) restricted the activities of NDU to codification, standardization and international relations with other depositories. However, on January 13, 2006, the Cabinet of Ministers lifted restrictions on the NDU and dismissed the MoU with the donor agencies 16 The takeover attempt took place in spite of MFS’ own statutes, in which one shareholder is limited to a maximum of 10%. MFS has unsuccessfully to enforce its statutes in court. 17 See OECD Guidelines for the Corporate Governance of State-0wned Enterprises.
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The SSMSC is a public authority subordinate to the President and accountable to the Parliament (Verkhovna Rada) of Ukraine. The Commission is composed of a chairman and six commissioners appointed for seven year terms; all are appointed and dismissed by the President upon approval of the Parliament.18 The SSMSC has 234 employees in Kyiv and 500 in other cities. The SSMSC is financed from the State budget, and revenue raised from fines or fees are returned to the State budget. In 2005, the budget allocation for the SSMSC was UAH 32.0 million (USD 6.1 million). Courts. Market participants have mixed views of the court system, with some feeling that courts have insufficient competence regarding commercial disputes. Indicators developed by the World Bank imply that the procedures and cost of recovery to enforce a standard contract in the Ukraine is typical for the region, and time required shorter, but also indicate that courts are more costly to use than in more developed economies (see Doing Business 2006 at rru.worldbank.org). Contract Enforcement Indicator Ukraine ECA Average19 OECD Average Number of procedures 28 29.6 19.5 Time (days) 269 393.0 225.7 Cost (% of debt) 18.1 17.4 10.6
SECTION II: THE RIGHTS OF SHAREHOLDERS AND KEY OWNERSHIP FUNCTIONS The corporate governance framework should protect and facilitate the exercise of shareholders’ rights.
Principle IIA: The corporate governance framework should protect shareholders’ rights. Basic shareholder rights include the right to:
Assessment: Partially observed
(1) Secure methods of Shareholder recordkeeping and ownership registration remains highly decentralized. ownership registration According to the Depository Law, ownership rights to registered shares issued in certificate form are recorded in a share register maintained either by the company itself or by an independent registrar. Issuers must employ independent registrars if the total number of registered shareholders exceeds 150. According to the SSMSC, there were 361 licensed registrars in operation at the end of 2005; there has been relatively little consolidation in the industry since the previous assessment in 2002.20 The share registration system has raised several concerns in the past. The system is generally slow and expensive (especially for frequently traded issues), is difficult to regulate (because of the large number of licensed registrars), and has not proved to be conducive to high degrees of transparency of ownership (because of frequent use of nominees and other intermediaries). Some registrars do not have the capacity to perform registrations within the three-day prescribed term or refuse to cooperate, increasing the length of the process to 10-15 days. This problem was exacerbated by “pocket registrars” (effectively under control of the issuer’s management or a significant shareholder), who may delay registering “undesirable” new shareholders. A more recent problem is the existence of “dual” registrars. In up to 15 cases, disputes between shareholders have resulted in court orders that have transferred registers to another registrar. Following the transfer, the company effectively has two different registries with different lists of shareholders. Nominee ownership is legal and widely used in Ukraine, and custodians play a major role in shareholder recordkeeping; there were 161 licensed “keepers” (custodians) at the end of 2005.21 Foreign investors are required to hold their shares through a custodian.22 ING Bank is the largest custodian in Ukraine; by its own estimates it now acts as custodian for 80% of all foreign investors in Ukraine.23 INGBU also acts as the sub-custodian for Bank of New York’s ADR/GDR programs.
(2) Convey or transfer shares Under current legislation, shareholders of public companies may offer their shares to third
18 Article 6, Law of Ukraine «On State Regulation of Securities Market in Ukraine» 19 Average for World Bank clients in Europe and Central Asia. 20 SSMSC, unpublished data. 21 SSMSC, unpublished data. 22 SSMSC, Decision # 138 23 ING Ukraine website, http://www.ingfn.com.ua.
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persons without restriction. Shareholders of closed JSC have preference to purchase shares from other shareholders.24 The Principles also recommend that shareholders have the right to freely transfer shares (§2.1.4) Although the LC stipulates free transfer of shares by shareholders, the right to sell shares freely is weakly enforced in Ukraine. According to the recent survey, about 25% of open joint stock companies surveyed responded that they had limitations on share transfer in their statutory documents. Most share transactions have traditionally been settled trade-for-trade by participants, directly at the registrar. A fraction of securities transactions are settled through MFS. As of January 1, 2004, the MFS serviced securities with a par value of UAH 32.1 billion (about USD 6 billion), or about 32 percent of all securities outstanding at the year-end of 2003. Most settlement operations are performed by the MFS on a non-delivery-versus-payment basis (the role of delivery-versus-payment has been increasing recently). The MFS acts predominantly as a settlement agent on a trade-by-trade basis and performs limited “clearing” function with netting of transactions. Improvements to shareholder recordkeeping and clearing and settlement are constrained by the fact that there is currently no central depository/clearing agency in Ukraine. The on- going disagreement over the future of the depository system has caused development of this crucial institution of the securities market (and the corporate governance framework) to lag.
(3) Obtain relevant and Under the LC, companies are required to provide shareholders with copies of balance material company information sheets, reports on activities, and minutes of shareholder meetings, upon request. In on a timely and regular basis addition, a shareholder has the right to inspect minutes of the management board meetings and obtain certified excerpts. The Law on Information and a subsequent SSMSC resolution require the company to provide the charter and founding documents to shareholders. The company charter may limit access to certain information. Shareholders also have access to periodic and ad hoc disclosure required by the Law on Securities (see Principle VA). The Principles recommend shareholders have equal and unrestricted access to complete and accurate information about the company. Information should be provided within 10 working days and company by-laws should set forth the principles of a communications policy ensuring shareholder access to information (§2.1.3&2.2d).
(4) Participate and vote in Persons holding shares of the company on the date of the shareholder meeting, general shareholder meetings irrespective of the number and class of shares they own, are entitled to participate in the meeting. Holders of common shares have the right to vote, as do holders of preferred shares in cases where the charter allows them to vote. See Principle IIC. The Principles recommend that companies establish a shareholder right to participate in the corporate governance of the company by attending and voting at the GSM. (§, Section 2.1.1).
(5) Elect and remove board Process. The Civil Code gives shareholders the exclusive right to vote to elect and members remove the members of the supervisory board, management board, and auditing (revision) commission. Cumulative voting/proportional representation. Cumulative voting or other requirements to place minority shareholders on boards are not stipulated by law, although shareholders may pool their votes through proxies or prior agreements to act in concert. The Principles recommend that members of the supervisory board be elected and dismissed by the GSM, that minority shareholders should have an opportunity to nominate candidates, and that shareholders should be provided with complete information about each candidate in advance. Ballots are recommended for board elections (§ 3.1.3).
(6) Share in profits of the Shareholders have a right to share in the profits of the company through distribution of corporation dividends. Decisions to declare dividends, including the amount, must be approved by the GMS based on recommendations from the management or the supervisory board. Dividends are distributed once a year and may only be paid out of the profits of the company. Owners of preferred shares are entitled to receive a fixed dividend, regardless
24 The pre-emptive rights of existing shareholders of closed JSC were established by the decision of the Constitutional Court of Ukraine №4-рп/2005 of May 11, 2005.
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of the profits received by the company. Since the LC does not specify the form of dividend distribution, many companies have distributed dividends in kind, using commodities or goods. Where the State owns a substantial block of shares, companies are required to allocate a certain percentage of net profit to dividend distribution (recently as high as 50 percent), even though the company may have other capital needs. A recently introduced provision in the Civil Code prohibits companies from paying dividends if it becomes insolvent. According to the 2005 IFC Survey, 20% of profitable JSC pay dividends to their shareholders. The voluntary Principles state that all shareholders have the right to share in company profits, that the same dividends should be paid to each share of the same class, that the company should have a transparent dividend policy, and that dividends should be paid within three months of the GSM (§2.1.2, 2.2c)
Principle IIB. Shareholders should have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as:
Assessment: Materially not observed
(1) Amendments to statutes, According to the LC and Principles, amendments to the company charter must be or articles of incorporation or approved by 75 percent of the votes present at the GMS. similar governing company documents
(2) Authorization of additional Issuing share capital. The relevant legislation on issuing new shares is not entirely clear. shares Issuance of share capital must be approved by the GMS but the charter may allow the management board to authorize capital increases of up to 33 percent of capital without prior shareholder approval. However capital increases also require amendments to the charter, and hence approval by a 75 percent supermajority at the GMS.25 In practice, the management board may issue shares as a “faits accomplis,” since it is difficult to reverse a subscription of shares. In addition, the management may prevent other shareholders from attending the meeting and thus secure the required vote. Pre-emptive rights. The LC stipulates that “existing shareholders have pre-emptive rights for the acquisition of additionally issued shares”. The SSMSC Regulation “On the Procedure for Increasing the Charter Fund” clarifies that existing shareholders have the right to subscribe for additionally issued shares in proportion to their existing shareholdings. The voluntary Principles recommend specific steps the company should take to enable shareholders to exercise their pre-emptive right, including sufficient time to exercise the right.
(3) Extraordinary transactions, Reorganizations of the company or a subsidiary must always be approved at the GMS by including sales of major 50 percent of the votes present, and liquidations require a 75 percent vote. Nominally, a corporate assets majority of votes at the GMS is needed to approve major transactions that exceed an amount specified in the charter. However, charters often do not set the threshold or delegate this power to the management, which results in a situation when management may legally dispose of substantially all assets of the company at its own discretion. The voluntary Principles state that shareholders should be able to participate in decisions on “…fundamental corporate matters, such as undertaking large transactions, reorganizing the company and other activities which may result in major corporate changes.” (§2.1.1). According to the UAIB survey in early 200226, violations of shareholder’ rights through transactions involving the sale of substantially all the assets of a company were very common. According to the 2005 IFC Survey, 29.2% of open JSCs and 48.5% of closed JSCs do not include provisions in their charters that limit the powers of the management board to enter into major transactions.
25 This idea is controversial – the Civil Code gives this power to shareholders, but the wording is unclear. 26 The survey was carried out in early 2002 by the Ukrainian Association of Investment Business (UAIB) based on information from 54 experts representing leading national investment funds and investment companies, brokerage companies, financial institutions, banks, governmental agencies, self-regulatory organizations, and the PFTS
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Principle IIC: Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures, that govern general shareholder meetings:
Assessment: Materially not observed
(1) Sufficient and timely Meeting deadline. Owners of registered shares must be given personal notice of information on date, location, shareholder meetings in a manner specified by the charter at least 45 days prior to the agenda, and issues to be date of the meeting. decided at the general Meeting notice. The notice must also be published in a local newspaper and in one of the meeting official government newspapers. Notices must specify the date, time, location and agenda of the meeting. The Principles encourage companies to provide a notice indicating the date, time and venue of the meeting, along with the meeting agenda. The company should also, within 10 days in advance of the GSM, inform shareholders about changes in the agenda. The Principles also provide a number of good practice recommendations related to the conduct of the GSM. (§2.1.1) Available information. Shareholders must be given an opportunity to review all documents relating to the agenda prior to the meeting and must be informed on any changes to the agenda no later than 10 days prior to the meeting. In the event the agenda proposes a change in share capital, the notice must also include detailed information on the proposal. However, according to the SSMSC, companies sometimes fail to serve notices of meetings, fail to serve them on a timely basis, or fail to provide access to agenda materials. Since the law does not stipulate the procedure for granting access to agenda information, companies often post it on a bulletin board the day before the meeting. Many companies also try to slip in important decisions by dealing with them in the “miscellaneous” section of the agenda. Quorum rules. Quorum is met if shareholders representing more than 60 percent of the votes are present at the GMS. If quorum is not met, the law does not envisage a possibility to convene a second meeting with lower quorum requirements, which often results in the failure of companies to hold a shareholder meeting for a long period of time. According to the 2005 IFC Survey, 80.7% of JSC held annual general meetings during the previous year. Court bans were the reason for not holding general meeting in 13% of the open JSCs that did not. The survey also indicated that 97.6% of JSC hold general meetings on one day, 89.4% hold the GMS on company premises, in 78.8% of open JSCs vote counting is conducted by a counting commission formed at the company.
(2) Opportunity to ask the Forcing items onto the agenda. Under law, all shareholders have the right to propose board questions at the general issues to the agenda no later than 30 days prior to the meeting. Issues proposed by meeting shareholders owning in aggregate more than 10 percent of votes must be included, others are at management’s discretion. There have been cases when this right has been violated by management. The Principles recommend that any shareholder resolution submitted 30 days in advance should be considered for inclusion in the GSM agenda. A personal notice sent to a shareholder whose motion was dismissed should state the grounds for such dismissal. Questions. Shareholders have no explicit right to ask questions during the meeting. The Principles recommend that shareholders should have the right to put forward questions and to obtain additional information about any provisions of the agenda or related materials, from the officers and other authorized representatives of the company. (§2.1.1)
(3) Effective shareholder The GMS can decide on the remuneration of board members and other company officials, participation in key but can also delegate this power to either the supervisory or management board. governance decisions In addition the GMS decides on changes to the charter or company objectives, dividends, including board and key major transactions that exceed a threshold in the charter, changes in share capital, executive remuneration policy company procedures and internal documents, and reorganization or termination of the company or a subsidiary.
(4) Ability to vote both in Proxy regulations. Shareholders can participate and vote in shareholder meetings either person or in absentia in person or by proxy. Under the new Civil Code there is no need to notarize proxies. The Principles contain detailed recommendations for the proxy voting process.
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Postal and electronic voting. Voting by mail or other means is not permitted.
Principle IID: Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership should be disclosed.
Assessment: Materially not observed
Ukrainian law mandates disclosure of direct control based on data provided by the share registrar or depository. There are no obligations to report indirect or ultimate ownership to the SSMSC or public. Cross-shareholding structures are common, and some pyramid structures have formed that can result in control disproportionate to ownership. Classes of shares. JSCs may issue common shares that each have one vote or preferred shares that receive a fixed dividend but do not vote unless allowed for in the charter. Shares with multiple votes or voting caps are not allowed, and preferred shares are limited to 10% of nominal capital. The new securities law lifts the limit to 25% and implies that JSCs may have different kinds of preferred shares (§6.8). The Principles reiterate the goal of one-share-one-vote, without any exceptions (such as setting a minimum number of shares to vote, voting caps, or non-voting shares). Ownership disclosure by companies. Companies are required to disclose general information on their ownership structure in the annual report, including the shareholdings of company officers and the name and shareholding (in number of shares and as a percentage) of shareholders owning 10 percent or more of the company’s shares.27 The Law of Ukraine "On Securities" provides that this information must be made public by the SSMSC. Compliance with this requirement is limited to direct (nominal) shareholders, at best. Ownership disclosure by shareholders. Shareholders have no obligation to report their holdings to the public or SSMSC. Acquisition by an individual of 10% or more of a company’s shares is to be disclosed by the relevant registrar or custodian to the SSMSC, which then passes the information on to the public. Disclosure of shareholder agreements. There is no obligation to disclose shareholder agreements.
Principle IIE: Markets for corporate control should be allowed to function in an efficient and transparent manner.
Assessment: Materially not observed
(1) Transparent and fair rules Basic description of market for corporate control. Over the last few years the market and procedures governing for corporate control has been relatively active as “strategic” shareholders, including acquisition of corporate control foreign investors have increased their ownership and control. The market for control is unregulated and nontransparent. Acquisition of a substantial ownership interest in a (non-bank) company is currently regulated exclusively by anti- monopoly legislation, under which acquisition of control by one entity over another entity (in the form of a direct or indirect acquisition of shares that enables the acquirer to exercise 25% or 50% of votes in the highest governing body of the company) requires prior approval of the Anti-Monopoly Committee. The NBU must approve the acquisition of 10, 25, 50, or 75 percent of the shares of a Ukrainian bank. During 2006 the SSMSC took several steps to protect minority shareholders during mergers and other company transformations. The Commission introduced changes into the Regulation on the Procedure of Shares Issuing Registration and Information on Their Emission in the Period Companies' Reorganization, which provide for the redemption of shares at a market price from shareholders, within the period of company reorganization. Tender rules/mandatory bid rules. During a merger, shareholders that opposed the reorganization may sell their shares to the company at a price no lower than the nominal value. There is no mandatory bid or tender requirements triggered by the acquisition of a substantial number of shares. Delisting/going private. Most companies are not “listed” in the traditional sense on PFTS, since there is no contractual relationship between the issuer and the trade organizer. Instead, companies can be traded at the request of brokers, as long as both broker and company meet certain requirements. A 75 percent supermajority is needed at the GMS to change the company’s charter, and a 50 percent majority is needed to reorganize the company and convert from an open to a closed JSC. Squeeze out provisions. Ukraine has no legal requirements or thresholds where minority shareholders can or must sell their shares to significant shareholders. Share buy-backs/treasury shares. JSCs may buy and hold their own shares for up to
27 The Law of Ukraine "On Securities", Article 39.
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one year. The shares may be sold, distributed to employees, or cancelled (LC §32).
(2) Anti-take-over devices The law makes no explicit reference to anti-takeover devices and does not restrict their use. Some practices, such as poison pills or staggered boards, would not be possible under Ukrainian law. However, other tactics, like “the scorched earth policy” (i.e. sale of most valuable assets) or repurchase of the company’s own shares with subsequent distribution among “loyal” shareholders, have been employed by management to deter an unfriendly acquisition.
Principle IIF: The exercise of ownership rights by all shareholders, including institutional investors, should be facilitated.
Assessment: Materially not observed
Institutional investors (mainly investment funds) are active in exercising their voting rights in companies where they own substantial blocks of shares. Pension funds and insurance companies are less engaged in exercising their ownership rights.
(1) Disclosure of corporate Special Rules for Institutional Investors / Pension Funds. There are no rules governance and voting governing the disclosure of voting or voting policies by institutional investors. policies by institutional Voting Policy. There is no requirement to disclose voting or voting policy, and funds do investors not do so. Blocked shares/record date. To participate in the GMS, the shareholder must be registered in the relevant registry or depository. The law does not provide for a specific record date prior to the meeting.
(2) Disclosure of management There are no requirements for institutional investors to develop policies on or disclose of material conflicts of interest conflicts of interest, and institutional investors do not do so in practice. by institutional investors
Principle IIG: Shareholders, including institutional shareholders, should be allowed to consult with each other on issues concerning their basic shareholder rights as defined in the Principles, subject to exceptions to prevent abuse.
Assessment: Partially observed
While shareholders do consult with each other, limited access to ownership information may hinder some kinds of cooperation while facilitating certain abuses. Proxy solicitation or other formalities required. Shareholders may communicate without meeting proxy or other formal requirements. Rules on shareholder cooperation and “acting in concert”. The use of shareholder agreements is not prohibited, although their provisions should not conflict with mandatory statutory provisions and foundation documents. Provisions of shareholder agreements limiting rights of shareholders in a way which is not envisaged by law are not enforceable (e.g. a provision restricting a sale of shares for a specified time). There is no legal concept or equivalent of “acting in concert”, though Anti-Monopoly law does refer to “indirect” acquisitions.
SECTION III: THE EQUITABLE TREATMENT OF SHAREHOLDERS The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
Principle IIIA: All shareholders of the same series of a class should be treated equally.
Assessment: Materially not observed
(1) Equality, fairness, and Availability of share class information. Information on voting rights, including number disclosure of rights within and and type of shares, is published in the prospectus and charter. Number and type of shares between share classes for listed companies is also posted on the website of the PFTS and some other exchanges. The new securities law also requires issuers to report on the number and type of their securities in the annual and quarterly reports. Equal rights within classes. The new securities law notes that “common shares shall grant equal rights to their owners” (§6.6). The voluntary Principles note that companies should ensure equitable treatment of all shareholders owning the same class of shares (§2.2). Approval by the negatively impacted classes of changes in voting rights. Voting rights of preferred shares may be changed by a 75 percent vote of all shareholders October 2006 Page 22 Corporate Governance Assessment Ukraine
present at the meeting, including preferred shareholders if the charter allows them to vote. The Principles recommend that in the event that the GSM adopts a resolution which restricts the rights of preferred shareholders, they should have the right to vote on the resolution and that any shareholder who did not vote for or voted against the resolution should be entitled to the redemption of his/her shares at a fair price (§2.2b).
(2) Minority protection from Ability to call meeting. Shareholders owning in aggregate more than 10 percent of the controlling shareholder abuse; votes may demand that management convene an extraordinary shareholder meeting at minority redress any time and on any grounds. If, within 20 days, management fails to do so, shareholders may call the meeting themselves, although the cost of the meeting is then borne by the shareholders.28 A loophole in the LC allows management to call a meeting within the 20 day period but to set the date of the extraordinary shareholder meeting in the distant future, frustrating the purpose of the meeting. There is also no shorter notice period for extraordinary meetings - the full 45 days is required.29 Inspection rights. Shareholders may inspect the minutes of the management board meeting and the founding documents of the company. The GMS or shareholders owning 10 percent or more of shares may request the Auditing (Revision) Commission to audit the company. Withdrawal rights. Under SSMSC regulation, shareholders that oppose a reorganization of the company, such as a merger, can demand that the company buy back their shares at least par value. The Law on the State Privatization Program requires the company to buy back the shares of investors that oppose certain major corporate decisions. The Principles recommend that companies give shareholders rights in the articles to sell their shares, when the shareholder disagrees with certain fundamental decisions (§2.1.6). The Principles stress that the redemption price should be at market value, and that the list of issues covered should be specifically enumerated. Ability to challenge decisions of the general meeting. Shareholders can challenge the decisions of the GMS in court. Regulator redress. Shareholders can file a complaint with the SSMSC. The commission can investigate the complaint, and stop or reverse certain decisions or impose sanctions. Ability to sue board members. Shareholders have the right to file a suit against company or its officials for the violation of their rights. But individual suits against board members are very rare. The board is a collective decision-making body, and it is difficult for shareholders to prove guilt beyond reasonable doubt against any particular member of the board. Shareholders cannot file derivative suits against board members, other company officers or governing bodies on behalf of the company. Shareholders can also take legal action against the company, or file a complaint against directors with a government body. The Principles emphasize that the company should make every effort to prevent the violation of minority shareholders’ rights by officers of the company or controlling shareholders (§2.2d).
(3) Custodian voting by Nominee holders and custodians are common in Ukraine. Ukrainian law does not instruction from beneficial specifically regulate voting by nominees / custodians on behalf of beneficial owners. In owners. order to participate and vote in the shareholder meeting, nominees / custodians must obtain a power of attorney authorizing them to represent the beneficial owner at the meeting. As a matter of practice, leading custodian institutions that service large and often foreign investors voluntarily provide information and documentation on shareholder meetings to their clients, seek instructions with regard to the voting options and vote in accordance with such instructions. The Principles recommend that custodians who participate in a GSM should do so on the basis of a properly issued power of attorney, and under specific shareholder instructions (§2.5)
(4) Obstacles to cross border The contracts established between the GDR depository (generally Bank of New York) and
28 This provision is used in practice, although relatively rarely. 29 The court can play a role in this process. If the management fails to convene the extraordinary meeting at the request of shareholders holding 10% or more shares, courts will not intervene, because shareholders may convene the meeting themselves (although at their own expense). However, the management is required to convene an extraordinary shareholder meeting upon a written request of the supervisory board or the audit commission. If management fails to comply in this case, the court may issue an order compelling the management to convene the meeting.
October 2006 Page 23 Corporate Governance Assessment Ukraine voting should be eliminated. Ukrainian companies that have issued GDRs abroad do not give voting or explicit proxy rights to the GDR holder, though in practice some custodians do vote based on the instructions of the GDR holder. The Principles recommend that the company should provide foreign shareholders with equal opportunities to exercise their rights. Specific recommended measures include posting notices in foreign languages, and using modern means of communication (fax, e- mail, etc.) to provide information to shareholders (§2.1&2.3).
(5) Equitable treatment of all Voter registration for the GMS is carried out by the management board or the independent shareholders at GMs registrar. There have been instances when “undesirable” shareholders are refused registration on various grounds and thus prevented from participation in the meeting. Another problem encountered during registration procedure is false registration of shareholders or their representatives. The SSMSC and/or shareholders holding in aggregate more than 10 percent of votes may appoint their representatives to monitor the registration procedure. The law does not specify the voting procedure that must be used at a shareholder meeting. In practice, voting is carried out at the discretion of the company either by show of cards or by a ballot system. A “tabulation commission” is not required by law, although most companies establish one for the meeting. Members of the tabulation commission are usually appointed by the management, which raises doubts about their independence and objectivity. The Principles recommend that shareholders should have an opportunity to examine documents related to the GSM, should be able to participate in the discussion and vote for (and against) motions included in the agenda, and that voting procedures should ensure the transparency and accuracy of the vote count. Key recommendations include the establishment of a special counting committee, and the use of formal ballots. The Principles recommend that companies should hold GSMs in the city in which the company is located. (Principles, Section 2.1.1) According to the 2005 IFC Survey, 11.8% of open JSCs and 4% of closed JSCs use ballots to vote on all agenda items, 2.1% of open JSCs and 2.6% of closed JSCs – to vote on certain agenda items. In 71% of closed JSCs show-of-hands vote is used.
Principle IIIB: Insider trading and abusive self-dealing should be prohibited.
Assessment: Partially observed
Basic insider trading rules. Until recently Ukrainian law did not prohibit or restrict the use of insider information in securities trading operations. Instances of insider trading are reportedly quite common on the market. The new securities law prohibits insiders from using inside information for their own benefit, restricts the transfer of such information, and also prohibits third parties from using such information if they know it was provided by an insider. Inside information is defined as information that if made public “may significantly affect the value of securities”, excludes information that is publicly available, and allows the SSMSC to determine which information is considered inside information (§ 44.1-2,4). Insiders under the law include shareholders, company officials, persons or legal entities that have contractual relations with the company and government officials. Professional stock market participants should keep lists of insiders for the issuers whose securities they perform operations with (§ 44.3). The Principles also recommend that companies design internal mechanisms to prevent the misuse of insider information, including establishing in by-laws the duties of company officers and other insiders not to (i) disclose insider information to third parties, and (i)) purchase / sell company securities before such information is made public. Insider trading disclosure. The new securities law mandates the SSMSC to establish procedures for disclosure of inside information. It also requires securities professionals to inform the commission of any trades they suspect may involve inside information. Criminal/civil/administrative penalties. Under the new securities law, insider trading or passing on inside information can be punished by up to three years in prison, or the loss of the right to hold certain positions or engage in certain activities for up to three years.
Principle IIIC: Members of the board and key executives should be required to disclose to the board whether they, directly, indirectly or on behalf of third parties, have a material interest in any transaction or matter directly affecting the corporation.
Assessment: Not observed
RPT disclosure rules. Banks and some other Ukrainian companies follow IFRS for their financial reports, and hence should comply with IAS 24, which requires disclosure of RPTs. Ukrainian accounting standards have a provision similar to IAS 24, and this also requires some RPT disclosure. There are no other legal requirements in this area, RPTs are not defined in the October 2006 Page 24 Corporate Governance Assessment Ukraine law, and in practice RPTs are not disclosed. RPT approval rules/rules for approval of board/AGM. The LC and LS do not define related parties or RPTs or an equivalent concept and do not have any special rules for their approval. Conflict of interest rules and use of business opportunities. Under the LC and LS managers and board members are not expressly prohibited from entering into transactions that benefit them at the company’s expense and disclosure is not required. The LC only contains a vague provision that company officials are liable for damages caused by them to the company. As a result, conflicts of interest and the taking of corporate opportunities by managers and board members are common. Other legislation does refer to transactions between affiliated parties and potential conflicts of interest. The Law on Taxation and the Law on Banks require transactions between affiliated parties to be conducted on an arms length basis. The Law on Financial Services—which applies to insurance companies—does prohibit certain company officials from participating in discussions on and voting on transactions where they or a relative might have an interest. The Principles recommend that company officers disclose conflicts in a timely manner, related transactions be approved by the majority of members of the supervisory board, and the related party not take part in the discussion of voting. The terms and price of such a transaction should be fair, i.e. equivalent to those on which would be made on an open and competitive market (§3.3.2). In addition, company officers should not use opportunities of the company for personal gain, establish or participate in ventures that compete with the company, and that the company’s policy regarding loans to company officers should be clearly set out in company by-laws (§ 3.3.3-3.3.5).
SECTION IV: THE ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.
Principle IVA: The rights of stakeholders that are established by law or through mutual agreements are to be respected.
Assessment: Partially observed
Ukrainian law sets out the rights of employees, creditors, and other stakeholders vis-à-vis the company. Employees in particular have significant protection under the law. However companies do not have a strong record of respecting the rights of stakeholders. Stakeholder participation in corporate governance. Under the LC trade union representatives have the right to participate in supervisory board meetings in an advisory capacity. Decisions on socio-economic issues must be approved with the participation of the labor collective or trade unions. Usually, a list of such issues is specified in the company charter. Corporate social responsibility and codes for stakeholders. General awareness of corporate social responsibility is low. The voluntary Principles encourage companies to attend to the established rights of a broad circle of stakeholders, i.e. employees, creditors, territorial community etc. Furthermore, the Principles promote the concept of co-operating with employees in order to achieve wealth and sustainability goals.
Principle IVB: Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights.
Assessment: Partially observed
Redress mechanisms available to stakeholders. Constitution of Ukraine establishes the right of all persons to seek redress in court for any violation of their rights. In addition, any individual whose constitutional right has been violated may approach the Ombudsman in the Parliament for redress30. A State Labor Inspectorate carries out periodic inspections to identify employment violations. Creditors may seek enforcement of their contractual rights or institute bankruptcy proceedings against a debtor in a commercial (arbitrazhny) court. Under investment legislation, if an investment is properly registered, investors have the right to claim redress, and state guarantees the investment. As noted under ID, courts in Ukraine can be costly to use and market participants are not always satisfied with their performance. This can impede stakeholders seeking to obtain effective redress for violation of their rights.
Principle IVC. Performance-enhancing mechanisms for employee participation should be permitted to develop.
Assessment: Largely observed
Rules on employee stock option plans. Employees may be granted, at the sole discretion of the company, the right to
30 Under the Labor Code, employment disputes may also be referred to a commission established at the enterprise for resolving disputes between management and employees. This is an obsolete mechanism of dispute resolution employed during Soviet times and rarely used.
October 2006 Page 25 Corporate Governance Assessment Ukraine share in profits of the company through bonuses. Stock option plans are not common, although the company may distribute shares repurchased by the company among employees. The voluntary Principles encourage the distribution of company shares, profit sharing and other incentive mechanisms to motivate employees for the benefit of the company (§6.3).
Principle IVD: Where stakeholders participate in the corporate governance process, they should have access to relevant, sufficient and reliable information on a timely and regular basis.
Assessment: Partially observed
A general right to information is granted to various stakeholders by law. Documents not deemed to constitute a commercial secret are in theory made available to any person upon request and include: the charter, annual reports, tax returns, and other publicly available documents. In addition, employees have statutory rights to access financial statements of the company, and unions are allowed to attend board meetings in an advisory role and access information needed to negotiate the collective labor agreement. The right to information is often violated. Unless one is a shareholder, obtaining information from the company is very difficult. The Principles recommend that the company provide stakeholders with information necessary for effective cooperation, including timely information about the financial state and performance of the company and its governance structure. (6.2)
Principle IVE: Stakeholders, including individual employees and their representative bodies, should be able to freely communicate their concerns about illegal or unethical practices to the board and their rights should not be compromised for doing this.
Assessment: Materially not observed
Whistleblower rules. There is no specific protection for whistleblowers under the law. While employees can only be dismissed legally for a cause listed in the Labor Code, in practice this is believed to offer whistleblowers or other employees limited protection.
Principle IVF: The corporate governance framework should be complemented by an effective, efficient insolvency framework and by effective enforcement of creditor rights.
Assessment: Partially observed
Effectiveness of bankruptcy, security/collateral, and debt collection/enforcement codes. Creditors have rights outlined in insolvency and bankruptcy laws, and may also influence certain decisions of the company when solvent. Standard measures developed by the World Bank indicate that while legal rights for creditors are strong, information on credit and borrower quality essentially nonexistent. See Doing Business 2006 at rru.worldbank.org 31 Indicators of Creditor Protection Ukraine ECA Average OECD Average Legal Rights Index (out of a possible 10) 8 5.6 6.3 Credit Information Index 0 2.5 5.0 Public credit registry coverage (% of adult population) 0 1.4 7.5 Private bureau coverage (% adult population) 0 6.6 59.0
SECTION V: DISCLOSURE AND TRANSPARENCY The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.
Principle VA: Disclosure should include, but not be limited to, material information on:
Assessment: Materially not observed
(1) Financial and operating Annual report. The Law on Securities requires publicly traded companies to file annual results of the company reports to the SSMSC. Originally only open JSCs were required to file, now both open and closed JSCs are required to by the SSMSC. The deadline for filing is April 30. The Law On Accounting obligates all open JSCs, banks and financial institutions to publish their financial statements on an annual basis by June 1. In practice, this requirement is
31 Average for World Bank clients in Europe and Central Asia.
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poorly observed and no government agency seems to monitor its enforcement. Companies with subsidiaries are required to prepare and disclose consolidated financial statements in addition to separate statements for each corporate entity. The Principles recommend that companies disclose audited financial statements for the last three years and should publicize the annual report not later than three months after the end of the financial reporting year (§4.1.1b). Almost all companies surveyed by the IFC in 2005 claimed to fulfill their legal requirements to provide financial information. 10.7% of JSC mail annual reports to shareholders, at that, among closed JSCs the share of such companies is greater than among open JSCs – 12.4% versus 9.2%. 81.5% of surveyed companies distributed financial information to shareholders at the AGM. However, 6.9 percent of companies did not provide information on the results of annual audit. Quarterly report. The LS requires issuers to publish quarterly reports that include financial statements and basic information on the company and its officials. Companies with more than 10 percent of State ownership are required to file quarterly reports.32 The Principles recommend all companies do so not later than 2 months after the end of the reporting quarter.
(2) Company objectives As part of the annual report, companies must disclose information on their commercial objectives (production, assets, financial status, prospects regarding products and services, financing and R&D policies) and other information that may be material for investors to assess the financial status and operational results of the company.
(3) Major share ownership and Companies are required to disclose the shareholdings of company officers and the name voting rights and shareholding (in number of shares and as a percentage) of shareholders owning 10 percent or more of the company’s shares in the annual report. Acquisition by an individual of 10% or more of a company’s shares is to be disclosed by the relevant registrar or custodian to the SSMSC, which then passes the information on to the public. Shareholders have no obligation to report their holdings to the public or SSMSC, and there is no concept of ultimate or indirect ownership in LS or LC. Company share registers are not open to the public, registered owners may only obtain information on their personal accounts. The Principles recommend that companies disclose information about the “ultimate owners” of “large stakes” (4.1.1c).
(4) Remuneration policy for Currently there is no requirement for companies to disclose remuneration or loans paid to board and key executives, and members of the supervisory board and the management board, either collectively or information about board individually. However, companies are required to disclose general background information members on members of the supervisory board and the management board, as well as their respective shareholdings. Employee incentive plans, such as share ownership plans or profit sharing schemes do not have to be disclosed. The 2005 IFC Survey revealed that 38.7 percent of companies do not disclose remuneration information. The Principles recommend that companies disclose board member experience, qualifications, independence, and compensation (including share ownership) (4.1.1d) and provide shareholders with information about board nominees before the GMS. (3.1.3).
(5) Related party transactions Open joint stock companies (and banks and other financial institutions) are required to follow national accounting standard 24, which is reportedly similar to IAS 24, and requires annual disclosure of related party transactions. The limited numbers of companies who prepare accounts according to IFRS (including banks,) are also required to report related party transactions as part of the annual financial statements. However, market participants, including auditors, report that compliance is extremely limited.
(6) Foreseeable risk factors Companies are required to provide information on the risk factors that could affect company operations such as: political, financial and economic, production and technological, social and environmental risks. Risks that do not fall within these categories
32 SCSSM Decision №248 of September 04, 2001, «On Procedure of Submitting Quarterly Information by JSC and Holding Companies with Considerable Public Share in the Assessed Capital», registered at the Ministry of Justice of Ukraine №875/6066 of October 11, 2001.
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do not have be disclosed. In practice, in disclosing information on risks, companies are usually vague and too general, (citing “economic instability,” “legislative instability,” “low consumer purchasing power”). There is no requirement for the company to disclose its policies on risk management. Draft Regulation on Disclosure by the Securities Issuers, approved by SCSSM decision №717 of August 01, 2006, includes expanded disclosure requirements including labor relations, management and board members, and environmental issues. The Principles also recommend that companies should disclose major risk factors (4.1.1e).
(7) Issues regarding Policies relating to business ethics, environment and other community related employees and other commitments are not required to be disclosed by law. There is no legal requirement to stakeholders disclose information on management-employee relations, relations with stakeholders, business ethics, or public policy concerns. Companies are, however, required to provide information on the total number of employees and their cumulative compensation in the annual report. The voluntary Principles note that supervisory board should oversee interaction between the company and stakeholders.
(8) Governance structures and Basic corporate governance structures and policies are usually set forth in the charter of policies the company and are not disclosed elsewhere. Ukrainian companies are starting to adopt corporate governance codes. One problem is the fact that many companies fail to recognize the importance of information disclosure and lack sufficient resources. Comply-or-explain in force. The Principles recommend that companies should include in their annual reports information about their compliance with the Principles. However, there is no formal “comply or explain” rule enforced by stock exchange or regulator.
Principle VB: Information should be prepared and disclosed in accordance with high quality standards of accounting and financial and non-financial disclosure.
Assessment: Partially observed
Compliance with IFRS. Currently, all JSCs are required to prepare accounts in accordance with National Accounting Standards (NAS). The drafters of the NAS strove to incorporate requirements of International Financial Reporting Standards (IFRS) into these standards, and the NAS are periodically revised to take into account changes to IFRS. However while the Law states that local accounting standards should not conflict with IFRS, considerable differences remain.33 Companies with foreign investments often use IFRS in preparing their statements and the SSMSC has established a practice of accepting documents prepared according to IFRS, even though the law is silent in this respect. The NBU requires banks to comply with IFRS. It is estimated that approximately 200 Ukrainian companies use IFRS to prepare their financial statements. A draft Law on Accounting and Auditing would require all open JSCs to comply with IFRS. The Principles also recommend IFRS. Review/enforcement of compliance. The SSMSC oversees JSC disclosure, but has limited resources and does not review financial statements specifically for compliance with either NSA or IFRS. According to the 2005 IFC Survey, 7.9% of respondents said that they brought their reporting in compliance with the National Accounting Standards (NAS), as well as with the International Financial Reporting Standards (IFRS).
Principle VC: An annual audit should be conducted by an independent, competent and qualified, auditor in order to provide an external and objective assurance to the board and shareholders that the financial statements fairly represent the financial position and performance of the company in all material respects.
Assessment: Partially observed
Compliance with ISA. The Chamber of Auditors adopted International Standards on Auditing (ISA) as promulgated by the International Federation of Accountants (IFAC) on April 18, 2003. However, market participants report that in general only the international network firms are conducting audits according to ISA. Who must be audited? All open JSCs must issue audited financial statements. According to the 2005 IFC Survey, audits were conducted at least once per year in 90.2% of open JSCs and 82.1% of closed JSCs. Auditor independence. The adoption of ISA includes the full adoption of the IFAC code of ethics. Under the law, company accounts must be audited annually by an independent auditor or auditing firm that is selected by the company. Current law
33 The gaps between international standards and national standards, other deficiencies in the accounting framework, are reviewed extensively in the Accounting and Auditing ROSC.
October 2006 Page 28 Corporate Governance Assessment Ukraine defines independence as (i) no direct family relations with the company’s management; (ii) no personal interest in a company; (iii) not a member of a governing body, founder or owner of the company; (iv) not employed by the company; (v) not an employee or co-owner of a subsidiary or branch of the company. Current legislation does not prevent an auditor from providing other fee-generating services to the company and does not require auditor rotation. The requirement of auditor independence is commonly violated and “pocket” auditors (controlled by the company) are widespread. Moreover, there are no enforcement procedures or sanctions against companies for selecting a non-independent auditor. The Principles also recommend that the company be audited in accordance with international auditing standards (5.1.2) Audit committee. Ukrainian JSCs do not have audit committees made up exclusively of supervisory or management board members. Competent and qualified audit enforcement. The Chamber of Auditors exercises a general regulatory and supervisory function and is authorized to establish audit standards, certify auditors, monitor enforcement of audit standards and apply disciplinary sanctions. Under rules recently established by the Chamber, audit firms are supposed to review each others work, or have it reviewed by the Chamber. However the Chamber receives insufficient backing from responsible Government offices due to a lack of coordination and inadequate resources. Auditor qualifications. The Chamber sets auditor qualifications, including work experience and education, as well as passing a certification exam. The Chamber also requires continuous education for auditors. 120 accounting and audit professionals have also been certified by the British ACCA, and the big 4 four are well represented. However, most audit firms are small or sole proprietorships that will be challenged to meet ISA or review IFRS complaint statements. According to the 2005 IFC Survey, 1.1% of JSC engage international audit companies to perform financial statements’ audits. Auditing/Revision commission. The LC provides for the establishment of an auditing or “revision” commission in all JSCs. This commission is a distinct company organ, it is not a committee of either the supervisory or management board, whose members are elected by the GMS. The commission monitors the activities of the company, can audit the company at the request of 10% of shareholders or on its own initiative, and must prepare a report for the annual GMS. According to the 2005 IFC Survey, 83.7% of JSC have auditing commissions, and in 76.6% of JSC auditing commissions consist of three members. 14.8% of JSC have an internal audit service. The Principles recommend specific activities for the audit commission, including regular inspections, extraordinary inspections on its own initiative (or at the initiative of the GSM or supervisory board), and at the request of 10% shareholders (5.1.1b).
Principle VD: External auditors should be accountable to the shareholders and owe a duty to the company to exercise due professional care in the conduct of the audit.
Assessment: Materially not observed
Requirements for oversight of audit. Current laws also do not specify which governing bodies of the company appoint the auditor or determine the terms of appointment, such as fees. In practice, external auditors are often appointed by and report to the management board. According to the 2005 IFC Survey, in 59.4% of JSC decisions on independent auditor’s appointment are made by the management board, and 24.5% have replaced their auditors during the previous three years. The Principles recommend that the supervisory board approve external auditors, and oversee the efficiency, impartiality, and independence of the auditor and of his or her financial relations with the company (Principles 5.1.1a). Auditor accountability. Auditor accountability appears to vary widely, and is often to the management of the company. Auditor insurance. Auditor liability insurance is not required by law and regulation, and does not appear to be used in practice.
Principle VE: Channels for disseminating information should provide for equal, timely and cost-efficient access to relevant information by users.
Assessment: Partially observed
Material facts. “Special information” must be reported within two days. The law lists the types of information that are subject to the disclosure requirement. According to article 41 of the Law of Ukraine «On Securities», special information must be made public in an official edition of the Verkhovna Rada of Ukraine, the Cabinet of Ministers of Ukraine, or the Securities and Stock Market State Commission, and should be kept in a public database maintained by the Securities and Stock Market State Commission. The list of events that must be disclosed is insufficiently inclusive, and excludes events that may have material effect on the company’s financial state. The Principles recommend the disclosure of material events within two days and provide a number of examples. Published information (papers, web). Annual reports should be mailed to shareholders by post, but companies fail to disseminate such information on their own initiative, largely due to the cost involved. They usually provide copies of the reports to shareholders upon request (sometimes charging fees for photocopying). Annual reports are published in the press in an abridged version and with substantial delays. In addition, companies are required to file the annual report with one of 20 information agencies. The company pays a fee to
October 2006 Page 29 Corporate Governance Assessment Ukraine the information agency as part of the filing. The public can then in theory pay for access to this information from the information agency’s website. The agencies also pass the information on to the PFTS. In practice, many market participants report that the best and sometimes only way to obtain annual report information is directly from companies. The Securities Market Infrastructure Dissemination Agency (SMIDA), an affiliate of the SSMSC, is being relaunched and is supposed to provide certain information, including significant shareholders and material events. The PFTS IStock website has a wide range of corporate information compiled from various sources. According to the 2005 IFC Survey, 8.1% of all JSC use their own web-sites to publicize their financial performance indicators. The Principles recommend that companies have a clearly formulated communications policy, provide equal access to publicly available information and use “…convenient communication means which ensure equal, timely, and inexpensive access to information”, including the internet (§4.6, 4.4).
Principle VF: The corporate governance framework should be complemented by an effective approach that addresses and promotes the provision of analysis or advice by analysts, brokers, rating agencies and others, that is relevant to decisions by investors, free from material conflicts of interest that might compromise the integrity of their analysis or advice.
Assessment: Materially not observed
Disclosure and management of conflicts of interest by analysts, brokers, rating agencies, etc. The new Law on Securities requires asset management to be conducted separately from brokerage or other securities market activities and some financial intermediaries establish “Chinese walls” between various functions, such as custodial services and investment banking. There are no other provisions or requirements regarding potential conflicts of interest.
SECTION VI: THE RESPONSIBILITIES OF THE BOARD The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders.
Principle VIA: Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders.
Assessment: Not observed
Basic description of board. Ukrainian law provides for a two-tiered board structure. JSCs have a supervisory board and management board. Supervisory boards are mandatory in privatized companies, but are optional in other companies with fewer then 50 shareholders. The supervisory board is elected from among the shareholders34 by the GMS. The supervisory board may appoint the management board, or the charter may allow the management board to also be elected by the GMS. According to the 2005 IFC Survey, a supervisory board has been created in 73.7% of JSCs, including 97.4% of open JSCs with over fifty shareholders. The LC does not list specific powers or functions of the supervisory board, leaving this to the shareholder meeting or the company charter. In general, the law provides for flexibility in allocating the powers of the governing bodies, and this is often used by management to strengthen its position. However, in companies where a majority or controlling investor is present, the charters usually delegate more power to the supervisory board. Nomination and election. The Civil Code gives shareholders the exclusive right to elect and remove members of the supervisory board, management board, and auditing (revision) commission. This provision is contrary to international good practice, since it weakens the supervisory board by removing their power to appoint management. Eligibility requirements. Only shareholders may be members of the supervisory board. The LC also prohibits certain public servants, persons who have been prohibited from certain activities by the courts, and persons who have not served their sentences for certain crimes, from serving on the supervisory board. Company charters can have additional requirements, but rarely do so in practice. Banking Law requires bank board members to have a good business reputation, higher education, and a minimum amount of experience in the banking sector. The Principles recommend that members of the supervisory board should “…have the knowledge, qualifications and experience appropriate for accomplishing the company’s mission and pursuing its strategy” (including a basic knowledge of financial analysis), sufficient time to participate, and a solid reputation. Adequacy of duties of loyalty and care. The LC contains no provisions that establish the “fiduciary duties” of supervisory or management board members. The LC only stipulates that members of the supervisory board and the management board have a duty to the company not to disclose commercial secrets and confidential information. The responsibilities of company managers are described in their employment contracts, which are regulated by the labor legislation and do not include any provision of duties of loyalty or due care or diligence. Due to the history of State-ownership, there is a general lack of legal and cultural understanding by members of the supervisory and the management boards on acting in the best interests of the
34 Ukrainian law requires that members of the supervisory board must also be shareholders.
October 2006 Page 30 Corporate Governance Assessment Ukraine company. Under the Banking Law the “governors” (including board members and upper management) of a bank must act in the interests of the bank and its clients and must place interests of the bank higher than their own interests. They must perform their official duties with responsibility; adopt decisions within the competence granted to them; and must not use their official position for personal benefit. The Principles recommend that “Officers of the governing bodies of the company should act with due diligence and care in the best interests of the company, as may be expected from any sensible person in such a situation. The duty to act in the best interests of the company implies that a company officer should use his or her official position and related benefits solely in the interests of the company. Principles also note the importance of the “business judgment rule”, and ask the company to take into account the element of normal business risk involved in making important decisions and consider purchasing liability insurance for company officers (§3.3.6).
Principle VIB: Where board decisions may affect different shareholder groups differently, the board should treat all shareholders fairly.
Assessment: Not observed.
Majority shareholders often dominate the board and the principle of fair treatment of all shareholders is frequently violated. Under the law there is no concept of independent board members, and no other legal or regulatory barriers that would prevent the supervisory or the management board from adopting decisions favorable to a certain shareholder group.
Principle VIC: The board should apply high ethical standards. It should take into account the interests of stakeholders.
Assessment: Materially not observed
There are no explicit requirements for the Supervisory or Management Board to take into account the interests of stakeholders, act in an ethical manner, or introduce a code of ethics for the company or its employees. The auditing (revision) commission is authorized to monitor the company and management board for compliance with the law. In practice however the commission usually consists of company employees and is not capable of independent or objective judgment. The CEO and chief accountant may bear personal criminal, administrative, or civil liability for breach by the company and/or company officials of applicable laws and regulations in the area of securities, taxation, employment, environmental protection, etc. Members of the supervisory board generally do not have such liability. The Principles recommend that the company respect the rights of stakeholders, and notes that the supervisory board “ensures interaction” between the company and stakeholders (§ 6.1)
Principle VID: The board should fulfill certain key functions, including:
Assessment: Materially not observed
(1) Board oversight of general Board functionality by law, in practice, as recommended by Code. The LC gives the corporate strategy and major supervisory board power to oversee management, but does not specify the board’s role decisions regarding strategy or major decisions. Some of these powers reside in the GMS, though the charter may provide for such functions to be transferred or supplemented by either the supervisory or management board. In practice, almost all key decisions are made by management. According to the 2003 IFC survey most supervisory boards lacked such important functions as strategy making, and approval of annual plans and annual reports35. Article 39 of the Banking Law gives more explicit powers to supervisory boards, including the power to approve establishment, reorganization, and liquidation of subsidiaries, branches and representative offices. The Principles recommend that the executive board develop and coordinate with the supervisory board a draft annual budget and a draft company strategy (Principles 3.2.2) Director training, IOD. The SSMSC and the IFC have supported various training programs for board members and other company officers. The State Property Fund has supported training for board members and officials in companies with state ownership.
(2) Monitoring effectiveness of Outside of the broad mandate to oversee the management board, the law provides for no company governance systematic oversight of company governance practices by the supervisory board nor does practices it explicitly provide for any regular mandatory surveillance by the supervisory board over
35 See Corporate Governance Practices in Ukraine: 2003 Survey of Joint Stock Companies. IFC. 2004
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management, or any provisions for formally influencing management decisions. The law allows the company to regulate such rights in charter. The Principles recommend that the supervisory board set the company’s goals, approve company strategy, and formulate company’s governance policies (Principles 3.1.1).
(3) Selecting / compensating / The Civil Code gives shareholders the exclusive right to elect and remove members of the monitoring / replacing key management board. This provision is contrary to international good practice, since it executives weakens the supervisory board by removing their power to appoint management. The law does not explicitly address the role of the supervisory board in compensating or monitoring key executives. Under Article 39 of the Banking Law the supervisory board appoints and removes the chairman and deputy chairman of the management, and approves compensation packages. The voluntary Principles state that the supervisory board should monitor the performance of the executive board and evaluate its performance on a regular basis (3.2.8).
(4) Aligning executive and As noted above, only bank boards have explicit power to set management compensation. board pay with long term Under the LC, the GMS decides on the salaries of officials, but this power can be company and shareholder transferred to other company bodies. interests The Principles stress that members of the supervisory board should be entitled to adequate compensation and incentives. Compensation should be set by the nomination and compensation committee based on a general compensation policy adopted by the company, and approved by the GSM (§3.1.13). Compensation of the executive board should be set by the supervisory board, following a review by the nomination / compensation committee, and should be linked to company performance. Executive compensation share ownership should be disclosed in the annual report (§3.2.6).
(5) Transparent board The LC does not address procedures for board election or nomination. In practice, nomination / election process (minority) shareholders are often given little information in advance about board candidates.
(6) Oversight of insider The LC does not address conflicts of interest or related party transactions. According to conflicts of interest, including the 2003 IFC survey, 23% of surveyed companies contained provisions concerning conflict misuse of company assets of interests in their company documents36. and abuse in RPTs The voluntary Principles and the model charter call for the supervisory board to oversee the detection, prevention, and resolution of conflicts of interest among company officers (§3.1.2.e).
(7) Oversight of accounting The LC does not give supervisory board explicit power or responsibility regarding financial and financial reporting reporting, audit or internal control systems. The Law on Accounting implies that the head systems, including of management board is responsible for the company’s financial statements. The auditing independent audit and control (revision) commission also prepares opinions on JSC financial and annual reports. systems Article 39 of the Banking Law gives the supervisory board power to appoint the external auditor. The Principles recommend that the supervisory board oversee the system of internal controls including internal audit, verify the accuracy of annual and quarterly reports, detect flaws in the control system, and approve and oversee the efficiency, impartiality, and independence of the external auditor. The supervisory board should also work to eliminate deficiencies identified by the auditing (revision) commission, internal audit service, and the external auditor during the audit (§5.1.1).
(8) Overseeing disclosure and The law does not specify which corporate body has this responsibility. communications processes The Principles recommend that the executive board bear responsibility for the accuracy of accounting, financial and non-financial information disclosed by the company, and implementing the company’s communication policy. The supervisory board should ensure control over the accuracy of information disclosed. In addition, the company secretary or another individual organize the process of information disclosure and ensure access to public information.
36 See Corporate Governance Practices in Ukraine: 2003 Survey of Joint Stock Companies. IFC. 2004
October 2006 Page 32 Corporate Governance Assessment Ukraine
Principle VIE: The board should be able to exercise objective independent judgment on corporate affairs.
Assessment: Materially not observed
(1) Director independence Director independence in law and in Code. Ukrainian law provides for a two-tiered board structure: the supervisory board and the management board. Independence of the supervisory board from management is not ensured, although members of one board may not be members of the other. There is no definition of director independence in the law. The potential for lack of objective judgment is aggravated by the lack of regulations on related party transactions and conflicts of interest. The Ukraine Corporate Governance Principles define director independence in detail, and recommend that at least 25% of supervisory board members be independent. Director independence in practice. Due to the large number of employee-shareholders in Ukraine, it is common for employees of the company to serve on the supervisory board (employees are usually even less independent). There is no “class” of professional board members in Ukraine and few people hold multiple board memberships.
(2) Clear and transparent rules Audit and Other committees. There are no legal requirements to create special on board committees committees of the supervisory board, such as audit, remuneration, or nomination committees. The Ukraine Corporate Governance Principles do recommend the creation of board committees. According to the 2005 IFC Survey, committees were created in 11% of JSCs with a supervisory board. The Ukraine Corporate Governance Principles recommend that companies consider forming standard and ad-hoc committees to assist with the work of the supervisory board and prevent conflicts of interest. These include an audit committee and nomination / compensation committee.
(3) Board commitment to Restrictions on the number of board seats. There are no general restrictions in the law responsibilities on the number of boards a person may serve on. The Principles recommend that companies set a limit in their bylaws on the number of seats one member may have. Board members of state-owned enterprises are restricted to serving on a total of three boards. Board meeting requirements. Companies normally stipulate how frequently the supervisory board should meet in their charter. In practice supervisory boards meet every quarter, management boards more frequently. The Ukraine Corporate Governance Principles recommend that the supervisory board should meet regularly and at least once every three months (3.1.7). Public availability of board attendance. Shareholders have a right to inspect the minutes of management and supervisory board meetings. According to the 2003 IFC survey, only about 18% of board members were paid for their services in 2003.
Principle VIF: In order to fulfill their responsibilities, board members should have access to accurate, relevant and timely information.
Assessment: Materially not observed
Members of the supervisory board, as shareholders, have access to information as do other shareholders. There are no special provisions on access to information by board members. In practice, access to additional information by the members of the board largely depends on their relationship with management. The use of independent external advice by board members at the expense of the corporation is possible only if this is expressly envisaged by the company charter or by-laws. Although the concept of the corporate secretary is not common in Ukraine, the introduction of such a position of corporate secretary has been recommended by the Corporate Governance Principles. The Principles recommend that members of the supervisory board should have access to complete and accurate information and an opportunity to ask for explanations and clarifications from the executive board (3.1.6). In addition, the supervisory board should have the power to contract with professional advisors (lawyers, auditors, etc.) at the expense of the company. (3.1.10)
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Ukraine Terms/Acronyms
Cumulative Voting: Cumulative voting allows minority shareholders to cast all their votes for one candidate. Suppose that a publicly traded company has two groups of shareholders; one shareholder holding 80 percent of the votes and a group of minority shareholders holding 20 percent. Five directors need to be elected. Without a cumulative voting rule, shareholders vote separately for each director. The majority shareholder can elect five directors since s/he can out - vote the minority shareholders by 80:20. Cumulative voting would allow a group of educated minority shareholders to cast all votes (five times 20 percent) for one board member, thereby allowing the chosen candidate to win that seat. GDP: Gross Domestic Product GDRs: Global Depository Receipts: GMS: General Meeting of Shareholders IFAC: International Federation of Accountants IFRS: International Financial Reporting Standards IPOs: Initial Public Offings ISA: International Standards on Auditing ISIN: International Securities Identification Number JSC: Joint Stock Companies LC: Law on Economic Companies LS: Law on Securities MFS: Mezhregionalny Fondoviy Soyuz: “Inter-Regional Stock Union” NBU: National Bank of Ukraine NDU: National Depository of Ukraine NSA: National Accounting Standards OTC: Over the Counter PARD: Professional Association of Registrars and Depositaries PFTS: Persha Fondova Totgovelna Systema: “First Stock Trading System” Pre-emptive rights: Pre-emptive rights give existing shareholders a chance to purchase shares of a new issue before it is offered to others. These rights protect shareholders from dilution of value and control when new shares are issued if they have the financial means to acquire newly issued shares. Proportional representation: Proportional representation gives shareholders with a certain fixed percentage of shares the right to appoint a board member. R&D: Research and Development RPTs: Related Party Transactions. The OECD Principles of Corporate Governance hold that it is important for the mar - ket to know whether a company is being operated with due regard to the interests of all its investors. It is therefore vital for the company to fully disclose material related party transactions to the market, including whether they have occurred at arms-length and on normal market terms. Related parties can include entities that control or are under common control with the company, and significant shareholders, such as relatives and key managers. Shareholder agreement: An agreement between shareholders on the administration of the company, shareholder agreements typically cover rights of first refusal and other restrictions on share transfers, approval of related-party transactions, and director nominations. SMIDA: Securities Market Infrastructure Dissemination Agency Squeeze-out right: The squeeze-out right (sometimes called a “freeze-out”) is the right of a majority shareholder in a company to compel the minority shareholders to sell their shares to him. The sell-out right is the mirror image of the squeeze-out right: a minority shareholder may compel the majority shareholder to purchase his shares. SSMSC: Securities and Stock Market State Commission UAIB: Ukrainian Association of Investment Business UCITS: Undertakings for the Collective Investment of Transferable Securities UICE: Ukrainian Inter-Bank Currency Exchange Withdrawal rights: Withdrawal rights (referred to in some jurisdictions as the “redemption rights”, or the “dis - senters”, “oppressed minority,” “appraisal” or “buy-out” remedy) give shareholders the right to have the company buy their shares upon the occurrence of certain fundamental changes in the company. This report is one in a series of corporate governance country assessments carried out under the Reports on the Observance of Standards and Codes (ROSC) program. The corporate gover - nance ROSC assessments examine the legal and regulatory framework, enforcement activities, and private sector business practices and compliance, and benchmark the practices and compli - ance of listed firms against the OECD Principles of Corporate Governance.
The assessments: n use a consistent methodology for assessing national corporate governance practices
n provide a benchmark by which countries can evaluate themselves and gauge progress in corporate governance reforms
n strengthen the ownership of reform in the assessed countries by promoting productive interaction among issuers, investors, regulators and public decision makers
n provide the basis for a policy dialogue which will result in the implementation of policy recommendations
To see the complete list of published ROSCs, please visit http://www.worldbank.org/ifa/rosc_cg.html
To learn more about corporate governance, please visit the IFC/World Bank's corporate governance resource Web page at: http://rru.worldbank.org/Themes/CorporateGovernance/
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