a corporate governance assessment of ukraine's state-owned aviation sector

7/28/2019 A Corporate Governance Assessment of Ukraine's State-Owned Aviation Sector

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A CorporateGovernance

Assessment

of Ukraines

State-ownedAviation Sector

The Caseof Antonov

Policy Handbook


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ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

The OECD is a unique forum where governments work together to address the

economic, social and environmental challenges of globalisation. The OECD is also

at the forefront of efforts to understand and to help governments respond to newdevelopments and concerns, such as corporate governance, the information economy

and the challenges of an ageing population. The Organisation provides a setting where

governments can compare policy experiences, seek answers to common problems,

identify good practice and work to co-ordinate domestic and international policies.

The OECD member countries are: Australia, Austria, Belgium, Canada, Chile, the Czech

Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland,

Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand,

Norway, Poland, Portugal, the Slovak Republic, Slovenia, Spain, Sweden, Switzerland,

Turkey, the United Kingdom and the United States. The European Union takes part in

the work of the OECD.

www.oecd.org

OECD EURASIA COMPETITIVENESS PROGRAMME

The OECD Eurasia Competitiveness Programme, launched in 2008, helps accelerate

economic reforms and improve the business climate to achieve sustainable economic

growth and employment in two regions: Central Asia (Afghanistan, Kazakhstan, the

Kyrgyz Republic, Mongolia, Tajikistan, Turkmenistan and Uzbekistan), and Eastern

Europe and South Caucasus (Armenia, Azerbaijan, Belarus, Georgia, the Republic of

Moldova and Ukraine).

www.oecd.org/daf/psd/eurasia

Key Contact:Mr Antonio Somma

Head of Programme

OECD Eurasia Competitiveness Programme

[email protected]

Mr Daniel Blume

Senior policy analyst within the OECD Corporate Affairs Division, responsible

for the OECDs work on corporate governance in the Eurasian and Latin

American regions, as well as for corporate governance work with OECD

countries


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ACorporateGovernanceAssessmentof

UkrainesState-OwnedAviationSector:

TheCase

of

Antonov

NOVEMBER 2012


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The OECD Eastern Europe and South Caucasus Initiative

Launched in April 2009, the OECD Eastern Europe and South Caucasus Initiative

is part of the OECD Eurasia Competitiveness Programme, which aims to contribute toeconomic growth in Armenia, Azerbaijan, Belarus, Georgia, Moldova, and Ukraine. Itsobjective is to share with the governments of the region the knowledge, experience andgood practices of OECD countries to create a sound business climate for investment,enhance productivity and support entrepreneurship, develop the private sector, andbuild knowledge-based economies to render its sectors more competitive and attractiveto foreign investment. Its approach comprises both a regional policy dimension, whichentails peer dialogue and capacity building, and a country-specific aspect supportingthe implementation of a number of prioritised reforms. A sector analysis is alsoincluded, covering the formulation of targeted policies and strategies requested at theindustry level. Within the framework of the programme, public authorities, the privatesector and civil society in these countries have been engaged in a dialogue andcollaboration process to support policy actions and identify the key barriers to sectoralcompetitiveness.

The participation of all the stakeholders in the reform process, including foreigninvestors, is considered to be crucial for guaranteeing the effectiveness andtransparency of the recommended policies.


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Foreword

Since 2009, the OECD Eurasia Competitiveness Programme hassupported the Government of Ukraine in advancing national economicreform through its Sector Competitiveness Strategy for Ukraineproject. This Assessment contains specific conclusions of the secondphase of the project. It addresses specific policy barriers to improvecompetitiveness in one of the sectors with high investment potential,namely the state-owned civilian aircraft manufacturing sector, with afocus on corporate governance.

During phase II (2011-12) the OECD worked with the Government,private sector, international organisations and civil society to adviseon how to remove sector-specific policy barriers, exploiting its industryand policy expertise to focus on the most practical and effectivemeasures.

The project is conducted in collaboration with the Government ofUkraine and financially supported by the Government of Sweden.


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Acknowledgements

This Assessment has been prepared as an input into the workconducted by the OECD Eurasia Competitiveness Programme underthe authority of the Eastern Europe and South Caucasus InitiativeSteering Committee and the OECD Working Party on StateOwnership and Privatisation Practices, in consultation with theGovernment of Ukraine and with the participation of the private

sector in Ukraine.

It has been prepared based on input received through responsesto OECD questionnaires provided by stakeholders in Ukraine, alongwith interviews with relevant government agencies, Antonovmanagement, other stakeholders, and review of relevant

documentation.

Representatives of the administration of the President of Ukraine,several Ministries, government agencies, and state-ownedenterprises in Ukraine contributed to this work1. They include:

Iryna Akimova, First Deputy Head of the Administration of thePresident of Ukraine; Valeriy Khoroshkovsky, First DeputyPrime Minister of Ukraine; Andriy Klyuyev, former FirstDeputy Prime Minister of Ukraine and former Minister ofEconomic Development and Trade; and Volodomyr Horbullin,Former Head of National Space Agency of Ukraine, formerSecretary of the National Security and Defence Council,.member of National Academy of Sciences of Ukraine.

The Ministry of Economic Development and Trade: PetroPoroshenko, Minister of Economic Development and Trade;Anatoly Maksyuta, First Deputy Minister; VolodymyrBandurov, Deputy Minister; Volodymyr Pavlenko, Deputy

1 The contributions do not imply the contributors endorsement of the Assessment or itsrecommendations as a whole.


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Minister; Olena Kucherenko, Head of Department onInternational Cooperation and Foreign Technical Assistance;Mr. Vitaliy Maystrenko, Director of Department on Industrial

Policy; Mr. Veniamin Filatov, Deputy Chief of Unit on DefenceIndustry, Department on Defence and Security Economy; Ms.Tetyana Zinchenko, former Chief of Unit on InternationalCooperation and Foreign Technical Assistance; Ms. OksanaIvanova, Chief Specialist, Department on InternationalCooperation and Foreign Technical Assistance; and Mr. Vitaliy

Troyan, Chief Specialist, Department on InternationalCooperation and Foreign Technical Assistance.

Representatives of the State Agency on Public Equity andState Property: Mr. Dmytro Kolesnikov, Head; Mr. OleksandrKalenkov, First Deputy Head; Mr. Oleksandr Shubin, Advisor

to the Head of the State Agency on Public Equity and StateProperty; Mr. Sergiy Syrotyuk, Director of Department onInteraction with High-Tech Enterprises; and Mr. VolodymyrBalyasnikov, Deputy Director of Department on Interactionwith High-Tech Enterprises.

Representatives of the State-Owned Enterprise Antonov:Mr.Yurii Andriyenko, Vice President; Mr. Oleksandr Kiva, VicePresident; Mr. Valeriy Ivanov, Deputy General Director; andMr.Oleksandr Gridasov, Chief Specialist.

Participants to the Working Group on Machinery andTransport Equipment Manufacturing: Ms. Tetyana Kobzeva,Chief of Unit on International Investment Statistics, IndustrialStatistics Department, State Statistical Service of Ukraine;Mr. Yuri Prokopenko, Deputy Director of Department onMarket Research, Anti-Trust Committee; Ms. MyroslavaSobko, Deputy Director of Industries Department, StateStatistical Service; and Mr. Leonid Shofarenko, Chief of Unit

on Cooperation and Investments, State Aerospace Agency.

Experts who provided their inputs: Mr. Alexander Okunev,Director of Corporate Governance Centre at the UkraineInternational Institute of Business.


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The Swedish International Development Agency (SIDA) whichwas donor to the project and provided important guidance andsupport: His Excellency Stefan Gullgren, Ambassador of

Sweden to Ukraine; Mirja Peterson, Counsellor and SIDACountry Director Ukraine; and Olga Tymoshenko, SIDAProgramme Officer.

The Co-Chairs of the OECD Eastern Europe and SouthCaucasus Initiative, Sweden (His Excellency Anders Ahnlid,Ambassador and Permanent Representative of Sweden to theOECD) and Poland (His Excellency Pawe Wojciechowski,Ambassador and Permanent Representative of Poland to theOECD).

This Assessment was written under the guidance of CarolynErvin, Director of the Directorate for Financial and Enterprise Affairs(DAF).

James Colvin, consultant to the OECD, has served as leaddrafter, with additional input from Mr. Arto Honkaniemi, SeniorFinancial Counsellor, Prime Ministers office, Finland, representingthe OECD Working Party on State Ownership and PrivatisationPractices. Mr. Daniel Blume of the OECD Secretariat supervised thestudy with additional input from Mr. Hans Christiansen.

Antonio Somma, Head of the OECD Eurasia CompetitivenessProgramme and Gregory Lecomte, Policy Analyst, of the OECDSecretariat, respectively supervised and co-ordinated the UkraineSector Competitiveness Strategy Project, within which thisAssessment was carried out.

Local support in Ukraine was provided by Oksana Shulyar, LocalConsultant and former Adviser to the Head of the ParliamentaryCommittee of Ukraine on European Integration. Ms. Lyudmilla

Strelyanaya-Taranina provided interpretation and translation.


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Valuable administrative support was provided by AnnaChahtahtinsky, Orla Halliday, Elisabetta Da Prati, Lynn Whitney,Anna Soderstrom, and Katjusha Boffa.

This Assessment is published under the authority of theSecretary-General of the OECD.


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Table of contents

Acronyms and abbreviations ....................................................... 11

Executive summary...................................................................... 12

Assessment .................................................................................. 13Recommendations ....................................................................... 15

Introduction............................................................................... 18

Chapter 1: Background and context.................................................... 21

History of Antonov ....................................................................... 21Motivation for improved governance ............................................. 22

Chapter 2: Business description.................................................... 29

Antonovs current corporate structure ......................................... 29

SOE forms in Ukraine .................................................................. 31SOE Antonov ............................................................................... 32Antonov state aircraft manufacturing concern(Antonov concern) ...................................................................... 33Antonov manufacturing companies .............................................. 33

Chapter 3: Antonov and its legal environment............................. 35

Disparate ownership forms .......................................................... 35Challenges arising from the unitary enterprise structure ............. 37Industrial policy framework ......................................................... 42Financial transfers between Antonov and the government............ 43Regulatory issues ......................................................................... 46

Chapter 4: The ownership structure ............................................. 48

Enhancing the ownership policy for SOEs and for Antonov .......... 50

Improving the centralised (or coordinating) ownership entity ....... 51Reducing ownership entity involvement in day-to-daymanagement ................................................................................ 52Exercise of key ownership responsibilities should bestrengthened ................................................................................ 54

Chapter 5: Transparency and disclosure....................................... 57


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Annual audited reports ................................................................ 58Financial reporting standards ...................................................... 59Internal risk control ..................................................................... 60

Separation of military and civilian branches ................................ 61Chapter 6: Recommendations for reform...................................... 64

Legal form .................................................................................... 66Regulatory framework, industry assistance and state transfers ... 68Ownership ................................................................................... 69

Transparency / Disclosure........................................................... 71Board of directors ........................................................................ 74

Bibliography................................................................................... 77

Figures

2.1. Antonov Group Structure ...................................................... 30

Boxes

2.1 SOE forms in Ukraine ........................................................... 315.1 Boeing's approach to splitting civilian and military

activities ............................................................................... 63


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Acronyms and abbreviationsSOE Antonov State Owned Enterprise Antonov

Antonov Concern Antonov State Aircraft ManufacturingConcern

IFRS International Financial ReportingStandards

JSC Joint Stock Company

MRO Maintenance, Repair and Overhaul

OECD Organisation for Economic Co-operationand Development

PPP Public Private Partnership

R&D Research and Development

SIDA Swedish International DevelopmentAgency

SOE State Owned Enterprise

SPF State Property Fund

State Agency forCorporate Rights

State Agency for Management of theState Corporate Rights and AssetManagement

UAC United Aircraft Corporation

VAT Value Added Tax


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An update to Antonovs current governance structures couldbetter prepare the company to deal with this strategic shift, andwould harmonise its governance with the model of governance

being adopted by almost all of its likely competitors. The fast-paced nature of change in the sector will demand an ownershipand management model that can respond dynamically to the paceof industry reform. In short, for Antonov to be a world-classcompany in this environment, it will be necessary for the companyto move to a world-class system of corporate governance.

The Current Legal FormsCreate GovernanceChallenges

The existing corporate structure creates a number ofgovernance challenges, as follows:

Unitary Enterprises do not have a board of directors each unitary enterprise has a Director-General who isappointed under a performance contract and reportsdirectly to the ownership agency. There is no Board ofDirectors intermediating the relationship between theownership agency and the management of the companies.

A lack of financial flexibility Unitary Enterprises suchas SOE Antonov have no share capital and do not haveclear ownership of their underlying assets. There islimited capacity to restructure the capital of Antonov by wayof equity, short of vesting on them additional assets.

Legal restrictions on the capacity to enter into JointVentures- Ukrainian SOEs are forbidden to establish jointventures or corporate partnerships pursuant to the Decreeof the Cabinet. The original purpose of this legislation wasthe prevention of SOE management corruption. The ban

severely limits the capacity of Antonov to pursue strategicrelationships with manufacturers and suppliers.


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The legal arrangements for Unitary Enterprises do notaccord with private sector norms for example, theexemption of Antonov (as a Unitary Enterprise) from

insolvency and bankruptcy procedures creates significantperceptions of credit risk associated with the enforcement ofcompany debts, when the reality is probably that theGovernment would stand behind the company in the eventof financial stress.

The structure of Antonov Concern also raises governancechallenges. The Concern lacks control over the operations of theconstituent companies: it is not a holding company but acollegiate structure. This has a consequent negative impact on itscapacity to deliver its mandate. In addition, board members lack

independence. The board of the Concern is comprised of theDirectors-General of the constituent companies, whichcompromises the capacity of the Board to act in the joint interestsof the companies. There are no non-executive members of theboard of the Concern. Finally, there is an unclear relationshipbetween the Director-General of the Antonov Concern, and theDirector General of SOE Antonov (who is also Chair of theConcern).

Recommendations

Ownership Policy should bestrengthened

In the case of Ukraine, the key elements of an ownershipframework exist, although they are not unified in a consolidatedpolicy document. A consolidation of these elements into a unifiedpolicy would allow Ukraine to be more specific about its objectives

for the state-owned sector as a whole. This situation isexacerbated by the fact that there is a distribution of mandates

and functions between different government bodies. This meansthere is no single government entity with full oversight of the SOEsector and oversight responsibilities are spread across a numberof government ministries and agencies.


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Financial transfers between Government and Antonov arecomplex and involve a mix of various subsidies, capital injections,debt guarantees and tax holidays, offset by high dividend

obligations. Focused ownership would provide a framework fornegotiating more efficient capital funding and subsidyarrangements.

The biggest governance issue facing SOEs, and Antonov inparticular, is the extent to which the company is given thediscretion to function. The State Agency for Corporate Rights (theoversight body for Antonov) is significantly involved in thecompanies operations. The lack of a recognised board of directorshas created an oversight vacuum, which the Agency has filled.Reform to the governance structures would free the Agency to

adopt a more conventional ownership role, focusing on coreshareholder functions such as board appointment andperformance monitoring.

Transparency andDisclosure are Sub-Optimal

The level of disclosure by SOEs in Ukraine is generally poorcompared to international best practice. Ukrainian law does notstipulate making public the annual reports of SOEs, and in the

case of Antonov in particular, SOE accounts and other companyinformation may be treated as a state secret due to its strategic

and defence-related functions. Antonov releases its annualfinancial information based on local accounting standards,although the information lacks in both quality andcomprehensiveness. The financial statements provided by Antonovcontain less detailed disclosure than would be expected underInternational Financial Reporting Standards (IFRS). For instance,details of related party transactions are not disclosed, and (giventhe concerns regarding joint ventures and asset stripping), more

detailed and rigorous disclosure should be considered a thresholdrequirement. A move to IFRS reporting would represent asignificant advance.

There is a concern that the military elements of Antonovsoperations would militate against more comprehensive disclosure.

To the extent this is a concern, different levels of disclosure could


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be adopted for the military enterprises, while still allowing for thesynergies (and economies of scale) that would accrue fromcombining production.

Adoption of a HoldingCompany Structure wouldFacilitate Reform

The report makes a number of recommendations for reform,but the threshold measure is for the company to adopt a moreefficient corporate structure. The most viable arrangement would

be for a holding company to be established to assume thecoordination activities currently undertaken by Antonov Concern.

The holding company should be organised as a joint stock

company consistent with private sector norms. The three unitaryenterprises should similarly be transformed into joint stockcompanies, and be established as direct subsidiaries of theholding company. Adopting this form would put them on asimilar footing to their key global competitors and should bestructured in a way to provide them with maximum operationaland capital flexibility.

The use of the joint stock company structure provides anopportunity for the Government as owner to appoint highlyqualified boards of directors, who have the diversity of skills andexpertise to help Antonov meet the significant strategic challenges

that they face. The Boards would ideally be composed of amajority of non-executive directors and an independentChairperson. Board appointments should be made using openand transparent processes focused on merit, and includingprovisions to guard against conflicts of interest.

The holding company structure would also provide aframework for pursuing reform to the transparency and disclosureof the companies, and for managing the capital funding

framework. If necessary, military and civilian aircraft manufacturecould be quarantined into separate legal entities within thestructure.


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Introduction

As a part of the OECD Eastern Europe and South CaucasusInitiative (see Box below), a sector competitiveness project forUkraine was conducted as Phase I of a wider project to improvethe countrys sectoral competitiveness and investment framework.

The project follows a three-phase approach lasting five years(2009-14): first, it develops a sector competitiveness strategy(Phase I); second, it advises on specific policy options to addressexisting constraints (Phase II); finally, it creates mechanisms to

embed sustainable reforms (Phase III). The aim of this secondphase of the project, financed by the Government of Sweden, is toprovide advice on specific policy recommendations that can beimplemented to overcome the existing barriers to competitiveness.

This Assessment constitutes the output of Phase II of theproject. Phase I (2009-11) identified the sector-specific sources ofcompetitiveness for key sectors: agri-business (with a focus on thegrain and dairy value-chains), energy-efficiency and renewabletechnologies (with a focus on the biomass value-chain), and

machinery manufacturing and transport equipment (with a focuson the civilian aircraft value-chain). The analysis identifiedexisting challenges and suggested targeted policyrecommendations in each sector. Corporate governance wasidentified as an important barrier to competitiveness in the state-owned civilian aircraft manufacturing sector. The findings of

project Phase I are summarised in the Sector CompetitivenessStrategy of Ukraine report, which was released in 2012. Phase II(2011-12) focuses specifically on how to remove this barrier.

This Assessment makes recommendations concerning thecorporate governance framework for and practices of Ukrainesstate-owned enterprises involved in producing Antonov aircraft, inthe context of the Government of Ukraines broader approach tothe oversight of its state-owned enterprises. It assesses the

corporate governance of Antonov with reference to the OECDGuidelines on Corporate Governance of State-Owned Enterprises.


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For the purposes of this report, Antonov refers to the group ofrelated but separate Ukrainian SOEs involved in the design,marketing and manufacture of Antonov aircraft. The core SOE is

SOE Antonov, which has its foundations as the design bureau forall Antonov aircraft. In addition, there are two aircraftmanufacturing enterprises. These three companies are allincorporated as Unitary Enterprises, which is a corporate formthat has its roots in the Soviet legal system. Apart from thesethree enterprises, in 2010 the Antonov Aircraft ManufacturingConcern was established to provide for joint marketing of aircraftacross the design and manufacturing operations.


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Chapter 1

Background and context

History of Antonov

Ukraine is one of the few countries in the world currently

producing modern aircraft. The Antonov Design Bureau wasestablished in 1946 as a part of the USSRs wider aircraftmanufacturing sector, and it has since that time designed manyaircraft of different types and classes.

Ukraines involvement in the sector has its roots in the formerUSSRs capabilities in the aerospace sector. The USSR had adecentralised approach to aircraft manufacture, with design

bureaus separated from serial production. Antonov began as oneof the core design bureaus in the Soviet system. However, in

addition to the Antonov Design Bureau, Ukraine was (and is) alsothe base for a number of state-owned serial production plants,including the Kharkov State Aircraft Plant and the No.410 AircraftPlant for Civil Aviation. A third serial production plant, the KyivState Aircraft Plant, was merged with the Design Bureau in 2010to form the SOE Antonov.

After Ukraines independence, a number of the serialproduction plants, design bureaus and some of the sciencecentres involved in the aircraft sector were separated and

privatised. As such, the private sector also plays an active part inUkraines civil aircraft sector, with parts suppliers such as theengine supplier, JSC Motor Sich, and light aircraft manufacturersAeros, Aeroprakt and Aerokopter. However, the state hasmaintained Antonov as a state-owned enterprise because of itscentral strategic role in Ukraines economy and security.


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Antonov remains involved across the design and serialmanufacture of a wide spectrum of aircraft, including large cargoaircraft (AN-124, AN-225), military transporters (AN-70) and

civilian passenger aircraft (AN-148). There is also a focus on dualuse aircraft, that is, aircraft that can be adapted to both civilianand military use.

According to its latest financial statements, Antonov employsover 12,000 people. In the 2011 financial year it recordedrevenues of UAH 3.17 billion (~ USD 395 million)2, and profits ofUAH 193 million (~ USD 24.5 million). This was an increase fromthe previous year where revenues were UAH 2.28 billion (~ USD285 million) and profit of UAH 82 million (~ USD 10 million).

Motivation for improved governance

The aviation industry in Ukraine has been defined by theGovernment to be a sector that is strategically important for thesecurity and economy for the state. Reflecting this importance,in 2008 the Cabinet of Ministers in Ukraine adopted a Strategy forthe Development of the National Aircraft Sector for the perioduntil 2020.

The Strategy highlights that Ukraine has the potential to

increase the development and production of aircraft, and aircraftparts, across a range of aircraft types. However, there has been agradual reduction in research and technological potential in theaviation industry, and this has slowed Ukraines relative positionin the sector compared to other countries. Investment deficits,and a corresponding lack of competitiveness, are spread acrossresearch capacity, infrastructure and human capital.

The Strategy seeks to address this apparent decline byaddressing the organisational, legal, financial, economic and other

problems of the industrys functioning and development. TheStrategy makes clear that reform of the governance structures ofstate owned enterprises and in the ownership arrangements thatapply at the shareholder level, represent an element of that reformprocess, and also a tool to promote longer-term reform.

2 Based on an average USD/UAH exchange rate for 2011 = ~8.0.


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Antonov and the civil aviation industry is hampered by alack of access to finance

To provide a platform for future growth, the Strategy proposesstructural reforms to the industry. The governments plans forthe sector, and for Antonov in particular, include allowing themto: raise capital on market terms; partner with private enterprises(PPPs); and engage in more flexible procurement practices. Thisapproach is designed to help attract extra-budgetary resources forfinancial reform in the domestic aviation industry, and to reducethe spending of budget funds for industry development.

The OECDs 2012 Ukraine Sector Competitiveness Strategynotes that the Ukraine aircraft industry is limited in its financing

capacity in both the development phase and in customerfinancing. Aircraft manufacturing, especially in the developmentphase, requires a large amount of investment and a high risk-threshold. The financing needs of the industry include not onlyfinancing of aircraft development, but also financing of aircraftsales, and the provision of extensive after sales service (repair,maintenance and overhaul).

For Antonovs competitors, these financing needs are usuallyaddressed through banks and financial markets, risk-sharing

partnerships and various kinds of government support. TheUkrainian civilian aircraft industry is lagging on all thesedimensions. In Antonovs case, the sources of finance arecurrently significantly constrained compared to its competitors.

The strategy focuses on strategic partnerships

Because of the financing deficit, one key direction of theUkraine Government Strategy is to create conditions for furtherdevelopment of the aviation industry through engaging with

foreign strategic partners.

Antonov has already made some progress in this regard, withthe Antonov Concern entering into a form of joint venturearrangement with the United Aircraft Corporation (UAC) in


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Russia.3 According to recent media reports4, the joint venturewith UAC intends to manufacture 50 large freighter planes (An-124 Ruslan) and at least 150 military transport planes (An-70) in

cooperation with Antonov Concern by 2030.

It is likely that this reflects an ongoing process wherebycurrent and future production of Antonov aircraft will increasinglyrely on global partnerships, and risk sharing arrangements, withsuppliers and other manufacturers. For instance, with Antonovsnewest plane, the AN-148 regional jet, parts suppliers have beensourced from vendors in 14 different countries. Despite this, theheavy dependence on Russian partners has hurt Antonovs abilityto market the airplane outside its traditional sphere of influence.

If Antonov has ambitions to seek wider market access, it islikely that the company will need to continue pursue widercountry participation in its aircraft financing, development andmanufacturing. In this context, improving the governance andownership arrangements at Antonov will assist in increasing theirattractiveness to private sector investors.

Technological and strategic changes demand responsivemanagement

Aside from an increasing focus on commercial partnerships,strategic changes in the aircraft manufacturing industry are likelyto propel reform. Currently, four manufacturers dominate thepassenger aircraft market. Two of them, Airbus and Boeing, areleaders in the middle and large size segments; two others,Bombardier and Embraer, are leaders in the small size segment.

Competition is expected to intensify in the coming ten years, withnew players in all major segments. Apart from the existingplayers, Russia and China (via SOEs) and Japan (via Mitsubishi)are also championing investment in the sector.

3 United Aircraft Corporation was itself created in 2006 as a conglomeration of previousdisparate public and private sector actors in the Russian components of the former USSRaviation sector. Antonov has long-standing strategic and industrial ties to many of thecompanies subsumed within UAC.

4 Russian Aviation News, 29 May 2012, United Aircraft Corporation intends to manufacture50 An-124 Ruslan and at least 150 An-70 aircraft by 2030http://www.ruaviation.com/news/2012/5/29/1030/.


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An update to Antonovs current governance structures wouldbetter prepare the company to deal with this strategic shift, andwould harmonise its governance with the model of governance

being adopted by almost all of its likely competitors. The fast-paced nature of change in the sector will demand an ownershipand management model that can respond dynamically to the paceof industry reform. In short, for Antonov to be a world-classcompany in this environment, it will be necessary for the companyto move to a world-class system of corporate governance.

The OECD Model provides a way forward

In terms of the current study, the relevant questions are:

How can governance reforms be used as a lever to promotethe sector and to attract the interest of foreign lenders,investors and partners?

How would governance reforms provide the SOE with thenecessary commercial freedom to engage in thetechnologically complex and dynamic aircraft industry?

In the context of this greater commercial autonomy, whatwould be an appropriate ownership oversight regime to

ensure efficiency and to prevent wasteful or abusivepractices?

As these questions allude to, there are inherent tensions inpromoting governance reform. On the one hand, it is clear thatAntonov will require a large degree of autonomy in its financialand operational decision making to be able to successfullycompete in the aircraft construction section. On the other hand,the strategic nature of the aircraft sector and the large financialinvestment in Antonov requires a commitment to structured and

transparent governance and ownership oversight of theiroperations.

These issues are not unique to Ukraine, and in fact mostOECD member countries have had a great deal of experience in

addressing such problems. The OECD Guidelines on CorporateGovernance of State-Owned Enterprises represents the OECD


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members consensus view of the main features of an ownershipand governance model for SOEs that can address the enterprisesneeds for greater financial and operational flexibility, but retain

appropriate oversight of financial performance and long-termstrategy.

The OECD model assumes four layers of decision-making:

First, the Government decides at the cabinet level theoverall policy for state-owned enterprises (SOEs), includingthe objectives to be pursued by individual enterprises andits policy for the governance of state-owned enterprises.

These documents may be approved by the Parliament andserve as a benchmark for accountability and evaluation of

how well the government performs its ownership functionswith respect to company objectives.

Second, a centralised (or coordinating) ownership entityshould be established that communicates the agreedfinancial and non-financial objectives to the SOEs,nominates board members (or oversees this process), votesthe States shares (where relevant) and supervises SOEperformance. To avoid ad-hoc or day-to-day intervention inSOEs, the enterprises must be given explicit mandates and

objectives (commercial as well as non-commercial), thenallowed sufficient autonomy to pursue them. The centralownership entity must be designed to ensure thetransparency and accountability for the corporateobjectives, and to prevent political intervention beyondthese agreed objectives.

Third, the boards of directors of individual SOEs areestablished and required to formulate (or approve) corporatestrategies for complying with the financial and non-financial

demands on their enterprises, and to monitor the executivemanagement in its pursuit of these objectives.

Fourth, the executive management of each SOE should begiven sufficient autonomy and freedom from ad-hocinterventions by boards, ownership function andgovernment, to operate efficiently, maximise earnings and


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pursue corporate objectives in the public interest. Providingan intermediate board layer between the government andmanagement helps to ensure continuity and avoid paralysis

in the case of political uncertainty.

Structure of the analysis

Antonovs governance will be assessed within the framework ofthe OECD Guidelines. These suggest an analysis arrangedaccording to six separate themes: (i) Legal Framework (ii) State asOwner (iii) equitable treatment of shareholders (iv) role ofstakeholders (v) transparency and disclosure and (vi) boards. Inthe current analysis, the equitable treatment of shareholders isnot considered, given that Antonov is 100 per cent owned by

Government. Similarly the issues related to stakeholder relationsare not considered in great detail. While stakeholder relations areimportant, in terms of the immediate governance challengesfacing Antonov, they are not of the highest order.


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Chapter 2

Business description

Antonovs current corporate structure

In analysing the governance arrangements of the SOEAntonov, there are in fact a number of separate legal entities

that need to be considered. This includes the substantive entityresponsible for aircraft design, known as SOE Antonov, as well asa separate serial production entity.

In addition to these companies a new entity, the Antonov State

Aircraft Manufacturing Concern (Antonov Concern) was createdin 2010. This entity arose because of the historic legal andfunctional separation of design and serial manufacture. This

separation has acted as an impediment to the joint sales,marketing and representation of the various design andmanufacture companies involved in the development andproduction of Antonov aircraft. The Antonov Concern wasestablished to fulfil this joint representation role. Figure 1 showsthe key Ukraine state owned companies involved in the design,production and marketing of Antonov aircraft.


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Figure 2.1. Antonov Group Structure

Antonov State Aircraft Manufacturing Concern

SOE Antonov

- Design Bureau

- Prototype Production

- Fl ight test base

- Kyiv State Aircraft

Plant

Kharkov State Aircraft

Plant

No. 410 Aircraft Plant

for Civil Aviation

In conducting this review, there was some debate as to theappropriate entity on which to base the analysis. Thequestionnaire responses, reflecting the views of the participants,

were completed on the basis that the review was to solely focus onSOE Antonov, as the substantive design entity. It is arguable,however, that the review should encompass Antonov Concern andthe remaining production and manufacturing companies: theseentities form part of the complex of entities that the outside worldwould consider to be Antonov and, in terms of possible futuregovernance structures, it is likely that some greater degree ofintegration is likely among the various entities currently inexistence.5

Accordingly, this review considers the governancearrangements at both SOE Antonov and the Antonov Concern asthey are fundamentally inter-linked and a joint resolution of theirgovernance structures will be a pre-requisite of any reforms to the

existing arrangements. The analysis seeks where possible to takea holistic view of the various components of the state-ownedentities involved in the production of Antonov aircraft. However,within this framework, the review places a greater focus on thegovernance of SOE Antonov as the substantive and centralcomponent of the existing group of enterprises.

5 Indeed, SOE Antonov has already taken over the operations of a formerly independentproduction facility, the Kyiv State Aircraft Plant, with some expectation that they will alsoconsolidate the operations of the No. 410 Aircraft Plant.


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SOE forms in Ukraine

Ukraines SOE sector has a wide range of ownership and

management schemes, which are described in Box 2.1.

Box 2.1 SOE forms in Ukraine

The Commercial Code of Ukraine provides the basic legal framework for allcorporations in Ukraine, including SOEs, and regulates commercial relations.According to the Commercial Code of Ukraine, SOEs are broadly split between stateunitary enterprises and state corporate enterprises1:

State Unitary Enterprises: This enterprise form is similar to that existing inRussia (although in Russia it is mainly used at the municipal government level).Unitary enterprises have no ownership rights to the assets they use in their

operations, but are merely granted management rights. The underlying owner of theproperty (for instance, a government agency or Ministry) retains residual control overthe use and disposal of the property directly, but does not interfere in the day-to-dayoperations of the enterprise. There are no shares as such in a unitary enterprise,with income being distributed back to the state according to a set proportion set bythe Cabinet for each enterprise. There is no board of directors. The day-to-dayoperations of the company are under the sole control of a Director-General. Strategicdirection is provided by management in the first instance, with major companydecisions reviewed by the relevant ownership entity.

State Corporate Enterprises: Corporate enterprises are typically organised asjoint stock companies (although other corporate forms are possible). JSCs can beeither fully state-owned corporations or those SOEs where the government retains

dominant control over their business activities that is, those joint-stock companieswhere the governments share exceeds 50%. SOEs organised as joint stockcompanies can be either open (publicly traded) or closed (i.e. private). They mayalso include incorporated joint ventures, where the majority shareholder is thegovernment. SOEs that are incorporated as joint-stock companies are regulated bythe same legal framework for private sector enterprises listed on the stock exchange(e.g. with respect to transparency and disclosure, financial reporting, and therelationship with shareholders).

In addition to the above, the Commercial Code of Ukraine establishes anorganisational form called a Concern, which is particularly relevant in the context ofAntonov, since one of the principal entities in the corporate structure has adoptedthis form. Concerns are a structure adopted for corporate groups. It can be used forboth public and private companies. It is not a holding structure, but more in thenature of a cooperative or collegiate body. It allows companies to integrate theiroperations, without establishing a holding structure. Where a Concern isestablished, the members of the concern retain their full legal and operationalautonomy. Concerns are typically used to combine industrial enterprises, scientificorganisations, transport facilities, banks, trading enterprises, etc.


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The large number of corporate forms allowable for SOEs inUkraine is a reflection of historical development of thecorporations law that has allowed existing forms (such as the

Unitary enterprise) to remain, while introducing new forms thataccord more closely to modern commercial practice. Within thislegal context, the structure of the various entities within theAntonov group is described below.

SOE Antonov

The SOE Antonov is a product of Soviet era aircraft production.As noted above, the Soviet model involved separation of aircraftdesign from serial production. SOE Antonov is the successor tothe Antonov Design Bureau, and is considered the maincomponent of the Antonov business.

In 2009, SOE Antonov amalgamated with one of the stand-alone serial production plants, the Kyiv State Aircraft Plant, whichis responsible for production of one of Antonovs key currentproduction planes, the AN-148. The rationale for theamalgamation appears to have been both a response to thefinancial difficulties, which the Kyiv plant was in, but also to adesire to centralise the design and serial production of Antonovskey commercial product within one entity.

SOE Antonov is a unitary enterprise. It has a Director-Generalwho is also the Designer General of the company, reflecting thedesign-driven approach of the enterprise. The Director-General isappointed under a performance contract and reports directly tothe ownership agency; that is, there is no Board of Directorsintermediating the relationship between the ownership agency

and the management of the company. SOE Antonov does have amanagement board in place comprising the key executives of thecompany, who are all appointed by the Director-General.

In terms of product development, Antonov does obtain advicethrough a Scientific and Technical Council, which includes theDirector-General but is otherwise comprised of external experts.

This Scientific and Technical Council only provides specific advice


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on design, scientific and technology issues, and by no meansserves the oversight functions of a typical board of directors.

Antonov state aircraft manufacturing concern(Antonov concern)

The creation of the Antonov Concern was an apparentresponse to the difficulties that arise from the fact that the designof Antonov aircraft has historically been separated from serialproduction. The Concern was established to act as effectively a

joint marketing / representative entity of the design bureau andthe serial production companies. The companies that form the

Concern are SOE Antonov, Kharkov Aircraft Manufacturing

Company, and the No.410 Serial Production Plant.Because of its status as a Concern, (as opposed to a parent

company) Antonov Concern is not allowed to interfere in theoperations of the three entities, and these three companies retaintheir financial and operational independence.

A Management Board of Directors, chaired by the Director-General of SOE Antonov, oversees the Concern. The other

members of the management board are the Directors-General ofthe serial production companies and a representative of the

ownership agency (currently unfilled). There is also a separateDirector-General of the Concern, who is appointed by the Cabinetof Ukraine, and also sits on the management board.

Antonov manufacturing companies

Outside of SOE Antonov, there are two manufacturingcompanies that are aligned with the Antonov Concern: theKharkov State Aircraft Plant, and the No. 410 Aircraft Plant forCivil Aviation. Both of these companies are also established as

Unitary Enterprises. The Kharkov Plant is responsible forproduction of certain aircraft (An-74 and An-140) within theAntonov fleet, whereas the No.410 plant is focused onmaintenance, repair and overhaul of Antonov customer planes.


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It is important to note that these entities are legally andfunctionally separate from SOE Antonov, with their ownmanagement and capital. Their relationship to SOE Antonov is

purely through the joint representation of the Antonov Concern.There does not seem to be any obligations on Antonov to utilisethe serial production facilities to manufacture in their plants; theAn-148, for instance, has been manufactured under license by theVASO plant in Russia owned by the UAC.


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Chapter 3

Antonov and its legal environmentDisparate ownership forms

It is not uncommon in OECD countries that SOEs have aspecific, and sometimes different, legal form from othercompanies. This may reflect specific objectives or societalconsiderations. Where there are unique legal forms, the SOEsoften differ from the private limited liability companies throughthe respective authority and power of management and ministries;

disclosure and other regulatory requirements; and the extent towhich they are subjected to insolvency and bankruptcyprocedures.

Guideline (I.B) Governments should strive to simplify andstreamline the operational practices and the legal form under whichSOEs operate.

Where governments have reformed their SOE sector, thecommonly agreed best practice is that SOEs should be given alegal personality, and governance structures, organised alongbroadly the same lines as in listed or large private sectorenterprises. SOE forms should be based as much as possible oncorporate law and avoid creating a specific legal form when this isnot absolutely necessary for the objectives of the enterprise.


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Using the same form as private sector entities has numerousadvantages, some of which may be summarised as follows:

It helps to ensure a level playing field with the privatesector, such as with respect to the application of generallaws applying to the corporate sector;

It provides a governance and legal framework that isfamiliar to private sector creditors, suppliers andcustomers, which in turn helps the enterprise raise capitaland forge customer relationships;

Transparency, in particular, can be strengthened byapplying the same disclosure requirements, and accounting

and auditing standards, as required of private sectorcompanies; and

By formalising the shareholding structure, it provides amechanism to separate the ownership function ofgovernment from policy and regulatory functions.

Corporatisation of unitary enterprises has precedent

In this context, there has long been a process in Ukraine forstate unitary enterprises being transformed into state-owned

corporate enterprises, organised as joint stock companies. Asearly as 1993 a Presidential Decree (and related CabinetResolution) established a corporatisation process fortransformation of unitary enterprises into open shareholdingcompanies. These processes are still relevant; more recently(March 13, 2012) amendments to the Law On Managing StateOwned Objects has established that the Cabinet of Ministers ofUkraine shall define a new procedure for transformation of SOEsin state shareholding companies where 100 per cent of the shares

are owned by the State.

Some SOEs are defined as strategic

Apart from the division between unitary and corporate

enterprises, SOEs may also be classified as strategic enterprises,(and Antonov has been classified as strategically important for


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the security and economy of the state). Where this is the case,the Cabinet of Ministers reserves direct powers of approval for keytransactions, such as decisions on setting up, restructuring and

liquidating operations by the SOE.

In July 2012 the Ministry of Economic Policy and Tradeaddressed a number of ministries and state agencies with a DraftResolution of the Cabinet of Ministers for approval. TheResolution Draft entitled On amendments to the Resolution Draftof the Cabinet of Ministers of November 3, 2010 #999 containedthe following proposal:

Establishing that the SOEs strategic for the states economyand security encompass enterprises that meet one or a few

of the following criteria: aviation, space-rocket industry.

Beyond the commercial code, there are numerous other speciallaws and other legal acts stipulating mandate and functions of thevarious organisations entitled to manage state assets and exercisemonitoring, evaluation and oversight over the functioning of theSOE sector in Ukraine.

Challenges arising from the unitary enterprisestructure

Apart from a general policy preference for harmonising thecorporate form of SOEs around a Joint Stock Company model, thecontinued use of the Unitary Enterprise model creates specificgovernance challenges according to OECD experiences. (While theanalysis below is framed in terms of SOE Antonov, it appliesequally to the serial production companies that are all organisedas Unitary Enterprises.)

From an operational perspective, the Unitary Enterprise

structure, and its focus on management of assets, acts as animpediment to diversifying or extending their activities in newsectors and/or geographies. While these limits may be deliberate,

for instance, to prevent misuse of public funds, or to control SOEsuse of sensitive technologies, they also act as a significantconstraint on Antonovs capacity to dynamically deal with achanging business environment.


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SOE Antonov lacks a recognised board of directors

Guideline VI B. SOE boards should carry out the functions ofmonitoring of management and strategic guidance, subject to theobjectives set by the government and the ownership entity.

The OECD Guidelines recommend that state-ownedenterprises should have a board of directors with the necessaryauthority, competencies and objectivity to carry out their functionof strategic guidance and monitoring of management. Under theOECD model, the board of an SOE is assigned a clear mandateand is ultimately responsible for the companys performance. Theboard is responsible for acting in the best interests of thecompany and is held accountable to the owners, for instance, via

agreed performance targets and assessments of its performanceby the ownership entity.

In the chain of command, the Board carries out their functionsof monitoring of management and strategic guidance, subject tothe objectives set by the government and the ownership entity. Awell qualified board with a broad range of skills and experiencewould provide real strategic insight and guidance to themanagement of Antonov, across a broad range of areas includingaccessing financing; executing strategic alliances; and assessing

and guiding Antonov in channelling production to its potentialmarket strengths.

The Board should have the power to appoint and remove theCEO. In Antonovs case the lack of a Board means thatmanagement is concentrated in the hands of the Director General,

together with a management board appointed by him. While theownership unit monitors the Director-Generals performance (referfurther below), there is no process within the company to offer anystrategic guidance to the Director-General.

The flow on effect of a concentration of management power inthe hands of the Director-General is consequent increase in thelevel of oversight and intervention by Ministries and theownership entity in the affairs of Antonov. In effect, theimmediate layer of oversight normally assumed by the Board issubsumed within the ownership oversight role. In practice this


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means that all of the important business and operationaldecisions are made through the relevant managers of thesupervising ownership unit.

The current structure is financially inflexible

Guideline I. E - The legal and regulatory framework shouldallow sufficient flexibility for adjustments in the capital structure ofSOEs when this is necessary for achieving company objectives.

Antonovs corporate structure significantly limits its financialcapacity because of the unique approach to ownership of theunderlying assets of Unitary Enterprises. As a unitaryenterprise, Antonov has no share capital and does not have clear

ownership of its underlying assets. There is limited capacity torestructure the capital of Antonov by way of equity, short ofvesting on them additional assets.

With respect to debt finance, SOE Antonov (like other SOEs inUkraine) must get permission from state administration bodies(that is, the ownership unit and the Ministry of Finance) for anyexternal borrowing. Unitary Enterprises are unable tocollateralise their assets, which places quite significantconstraints on the structure of debt finance instruments that

Antonov can use, and the resulting cost. The net result is that itis very difficult for Antonov to obtain external finance, and thenecessary involvement of the state in the approval processeffectively ensures that any finance provided is not on marketterms.

Ban on joint ventures

One sensitive issue that arose in the course of the review wasthe capacity of state-owned enterprises in Ukraine to enter into

joint venture6 arrangements. Ukrainian SOEs are forbidden toestablish joint ventures pursuant to the Decree of the CabinetMinisters on Special Issues of State Property Management(31.12.1992). The original purpose of this legislation was theprevention of SOE management corruption, in response to

6 In this context, joint ventures include all forms of corporate partnership, including unincorporated jointventures and incorporated joint venture companies.


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numerous examples through the 1990s of insiders usingpartnerships with external parties or sham companies to stripassets out of SOEs.

An outright ban on joint ventures and shareholdingpartnerships with other companies is clearly detrimental to thecapacity of Antonov to compete on a meaningful basis with itsinternational competitors. In fact, as noted above, Antonov hasentered into some form of strategic partnership with the UnitedAircraft Corporation of Russia within the last two years,suggesting that there are means of structuring transactions toavoid the current prohibition.

It was suggested to OECDs mission team to Ukraine that one

rationale for creating the Antonov Concern was because theprohibition on joint ventures did not apply to Concerns. Ifcorrect, the question it raises is whether the Concern structurehas been adopted because it provides the most appropriatestructure to achieve Antonovs corporate aims, or has principallybeen adopted to overcome restrictions relating to joint ventures. Ifthe latter, then a more stable long-term solution to the regulationof joint ventures may open up the potential of more stable groupholding structures. In this context, there would appear to be somedrawbacks of the Concern structure for achievement of Antonovsobjectives, which are discussed further in section 3.2.4 below.

The unitary enterprise structure heightens risk

While use of Unitary Enterprises was widespread throughoutthe former Soviet Union, as a form of corporate organisation it is

not widely understood outside of the region. Potential financial orstrategic partners are more likely to understand, and becomfortable with, the norms associated with a Joint StockCompany structure, particularly in relation to the legal powers of

the board, and the control of the company over its assets.

Guideline I.D. SOEs should not be exempt from theapplication of general laws and regulations. Stakeholders,including competitors, should have access to efficient redress andan even-handed ruling when they consider that their rights havebeen violated.


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For foreign investors and strategic partners, a key issue will bethe extent to which they have access to efficient redress and aneven-handed ruling when they consider that their rights have

been violated. The Guidelines recommend that SOEs should besubject to the same general laws as private companies. In thecase of Antonov, the Unitary Enterprise structure createsunnecessary potential risk, and more particularly perceptions ofrisk, around third parties ability to pursue legal remedies.

In a substantive sense, the exemption of Antonov SOE (as aUnitary Enterprise) from insolvency and bankruptcy procedurescreates significant perceptions of credit risk associated with theenforcement of company debts, when the reality is probably thatthe Government would stand behind the company in the event offinancial stress. As an example, in 2009, Kyiv Serial Plant issued

government-guaranteed bonds (later assumed by Antonov when itmerged with Kyiv Serial Plant) of almost 600 million UAH or 75million USD7. This was used to pay out outstanding accountspayable to banks and for the construction of new aircraft. Evenwith the government guarantee, the coupon rate of the bondsexceeded 11 per cent.

Perhaps the real issue for potential partners is not necessarilythe substance of the risk, but that the legal arrangements do notaccord with private sector norms, and so become difficult toassess. In contrast, systems of legal redress offered through theCompanies Law for a Joint Stock Company would be moretransparent, predictable and understandable than for a UnitaryEnterprises.

The Antonov concern structures governance

As an umbrella representative body, the Antonov Concern isnot the primary focus of this paper, which is more concerned with

the governance arrangements at the substantive companies. Tothe extent that it responds to the need for a more centralisedrepresentation of the component parts of the Antonov design andconstruction activities, then it would benefit from a moreformalised oversight structure and greater control over the

7 Based on an average USD/UAH exchange rate for 2012 = ~8.0.


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operations of the member companies. The accountability of theConcern for its performance will be frustrated by:

its lack of control over the operations of the constituentcompanies, and the consequent impact this will have on itscapacity to control delivery of its mandate;

the dual roles held by the Board members as directors ofthe Concern and also Directors-General of the constituentcompanies;

the lack of non-executive members of the board of theConcern (noting that there is the potential for arepresentative of the ownership entity); and

the unclear relationship that exists between the Director-General of the Antonov Concern, and the Director Generalof SOE Antonov (who is also Chair of the Concern).

If greater coordination of the design, manufacture and MROactivities of Antonov is required, then a holding companystructure would provide a more stable and efficient arrangement.Not only would this provide a mechanism to address thegovernance issues above, but it would also provide a framework to

generate operational efficiencies (such as through reducedcontracting costs) by moving the enterprises within the singlecorporate structure.

Industrial policy framework

Guideline I.A - There should be a clear separation between thestates ownership function and other state functions that mayinfluence the conditions for state-owned enterprises, particularlywith regard to market regulation.

Because of its critical role in the development of the domesticaviation sector, Antonov has dual roles as a financiallyindependent (profit making enterprise) but also as criticalinstrument for Ukraine industrial policy. This is not anuncommon situation for an SOE, and when these dual roles arise,they can sometimes be contradictory and can easily result in


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confusion and conflicts of interest between industrial policy andthe ownership functions of the state. This will particularly be thecase if the responsibility for industrial policy and the ownership

functions are vested with the same branch or sector ministries.

Commonly accepted best practice is that where impositions areplaced on an enterprise that are not commercial, this is best doneby explicitly recognising these obligations and directly fundingthem from the public purse for example, through performancecontracts. This can be done independently of the ownershipfunction and will facilitate a separation of industrial policy andownership. This, in turn, will enhance the identification of thestate as an owner and will favour transparency in definingobjectives and monitoring performance.

Financial transfers between Antonov and thegovernment

There are a number of financial transfers between SOEAntonov and the Government that reflect competing governmentobjectives. On its face, the structure of these transfers is nottransparent, equitable or efficient, perhaps reflecting thecompeting objectives. The strategic nature of Antonovsoperations has meant that it has benefited from subsidyprogrammes to promote both research and development and theconstruction of planes. In contrast, as a profitable enterprise, ithas also been required to pay dividends.

Guideline I.C Any obligations and responsibilities that anSOE is required to undertake in terms of public services beyond thegenerally accepted norm should be clearly mandated by laws andrelated costs should be covered in a transparent manner.

As a general concept, it is preferable that any subsidies

provided to Antonov should be targeted, measurable and adequateto address the non-commercial objectives of the company. Theyshould relate to specific projects being undertaken and arereferenced to the costs of those activities. The practice in the caseof Antonov is a mix of subsidies, tax holidays and equity


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injections to provide industry support, balanced against quitesubstantial dividend requirements.

Direct Subsidies

Antonov informed the OECD team that it has received one-timetargeted funds from the Government to increase Antonovs paidup capital. This funding is irregular and non-systemic. Forinstance, the annual accounts of Antonov for 2011 disclose thefollowing in relation to the direct subsidies received:

According to the Decree of the Cabinet of Ministers of UkraineNo. 871 dated 15 August 2011 On Approval of Procedure forAllocation of Budgetary Funds for Financing the Authorised

Capital of State-Owned Enterprises in the Aircraft Industry,the Ministry of Industrial Policy made an additionalcontribution to the authorised capital of the Enterprise bycrediting its settlement account with UAH 49.9 million (~USD 6million).

In terms of the recommendations of the OECD Guidelines,these subsidies are clearly mandated through the law and (beingbudget appropriations) are publicly disclosed. However, it wouldbe preferable that the subsidies for programme implementation be

directed to Antonov in the form of a direct revenue contributionrather than as a capital injection, to better reflect the nature ofthe payments in the accounts of both Antonov and theGovernment.

Debt finance subsidies

Guideline I.F SOEs should face competitive conditionsregarding access to finance. Their relations with state-ownedbanks, state-owned financial institutions and other state-ownedcompanies should be based on purely commercial grounds.

As noted above, the corporate bonds issued by Antonov benefitfrom an explicit government guarantee. Government guaranteesof debt can, to some extent, frustrate the objectives of establishingSOEs as separate legal entities: the existence of government as

debt guarantor confuses its role as equity owner, by changing the


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Governments risk preferences; and can lead to increasedsupervision of its operations by other areas of governmentconcerned with the contingent risk of the guarantee.

In any case, where guarantees are felt necessary (for instance,because of the lack of availability of finance without guarantees),it is preferable that some form of guarantee fee is paid toGovernment to reflect the risk. This has several positive benefits:it commercialises the guarantee arrangement and so potentiallyquarantines it from ownership issues; it prevents any inherentsubsidies from accruing to the SOE (inflating their financialperformance); and it should lead to more optimal capitalstructuring by introducing appropriate capital pricing signals.

Apart from the debt guarantees, Antonov notes that part of thetargeted funds for specific programmes was delivered via payingpart of Antonovs bond coupon yield. If, as appears, thesesubsidies relate to an industry-wide research and developmentprogramme, it is unclear why this should be structured as a bond

yield discount, rather than as a direct subsidy.

Taxation

The taxation arrangements applying to Antonov and the other

SOEs in the group are the same as those applying to the privatesector. However, while Antonov is subject to the Ukrainian taxlaws, the company benefits from a number of temporary taxholidays as follows:

It is exempt from the payment of income tax for a term of 10years, from January, 2011, while manufacturing airplanes;

It is exempt from the payment of VAT on imports untilJanuary, 2016 while it is importing commodities and

products of R&D for the needs of aircraft industry; and

It is exempt from the payment of land tax until January,2016.


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If, as seems the case, these taxation subsidies are designed topromote the competitiveness of Antonov in the manufacture ofairplanes, then they could be better structured. The nature of

income tax holidays are such that they are more valuable thegreater the profits of Antonov in other words, the less Antonov isin need of the subsidies, the greater the subsidies they receive.

Dividends

According to the latest financial statements, SOE Antonov wasrequired to pay dividends of UAH 54 million (~ USD 8 million), buthad operating cash flow of only UAH 23 million (~ USD 3 million).It was only able to make the dividend payment because of thereceipt of the capital subsidy of UAH 49.9 million highlighted

above. The receipt of dividends as cash and the payment ofsubsidies on capital account may have the benefit in terms of thepresentation of the national budget. However, from a commercialand/or policy perspective such an arrangement has limitedbenefits.

On the contrary, properly structured incentive based paymentsfor particular industrial development activities should bestructured on commercial terms, making the industrialdevelopment activities part of the profit-making activities of the

enterprise. It could be the case that the quite substantialdividend obligations placed on Antonov has limited its capacity toundertake capital investment and may limit research anddevelopment. If so, the provision of tax holidays and interestsubsidies should have simply been replaced with lower dividendrequirements, providing the company with capacity to adequatelyinvest for its future production and product innovation.

Regulatory issues

Procurement policy

The application of procurement rules to SOEs is often adifficult issue for governments. The reasonable requirement forprobity in government procurement, and sensitivity to promotinglocal content, often leads to more structured and lengthyprocurement processes being applied to SOEs. On the other


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hand, SOEs private sector counterparts are often not subject tothis constraint and this can cause SOEs to be at a competitivedisadvantage. The preference, expressed in the OECD Guidelines

is that the procurement rules applying to SOEs should be thesame as those applying to private sector companies. Legal as wellas non-legal barriers to fair procurement should be removed.

In Antonovs case, the company made clear during the reviewthat it considered the government procurement regime applying toits operations as incompatible with its operations which involvessourcing parts from specialist suppliers, often on a risk-sharingbasis. For many components, the choice of supplier was limitedand often based on multi-faceted criteria that often subordinatedsupply price to a secondary consideration. Antonov felt that the

rigidity of the government procurement regime was not only overlytime-consuming (reportedly taking between 4 and 8 months), butalso placed it at a considerable disadvantage to internationalcompetitors who operate very sophisticated, bespoke procurementsystems.

For its part, in July 2011, the state amended its publicprocurement law with the intention of mitigating administrativeinefficiencies. Under certain circumstances, the amendmentallows state-owned companies to bypass the tender process andpurchase goods or services through the procurement from asingle supplier procedure.8 Antonov was not included under thescope of the amendment and continued to apply previous tenderprocedures. However, according to the Law of Ukraine #4913-VI of

June 7, 2012 On amendments to the Law of Ukraine On StateProcurement Antonov SOE has also now been waived from

tender procedures. The implementation of this law should requireAntonov to develop internal procedures to ensure that there is ahigh degree of transparency and accountability in theirprocurement arrangements.

8 The single supplier clause has been sharply criticised by the EU as a mechanism that fuelscorruption and that is out of synch with EU criteria.


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Chapter 4

The ownership structureApart from potential reforms to the legal structure of Antonov,

the main focus of any reform to Antonovs corporate environmentshould be to examine how the formal governance arrangementscan be improved to ensure that:

Antonov can obtain the operational flexibility and autonomyit will need to conduct its operations in what is a dynamicmarket;

The government is well placed to pursue the strategic,industrial and financial aims it has for Antonov; and

There are suitable oversight mechanisms in place to ensurethat the company is performing according to theseobjectives.

As noted above, the commonly accepted best practice is thatthis is most efficiently achieved through a layered approach togovernance involving a strong ownership framework, structuredownership oversight and a well composed board of directors witha strong mandate and authority coupled with executivemanagement with sufficient autonomy to operate efficiently.


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Enhancing the ownership policy for SOEs and forAntonov

An ownership policy applying to all SOEs

Guideline II.A - The government should develop and issue anownership policy that defines the overall objectives of stateownership, the states role in the corporate governance of SOEs,and how it will implement its ownership policy.

In the case of Ukraine, the key elements of an ownershipframework exist, although probably not unified in a consolidatedpolicy document. For instance, there are policies and legislationdealing with: the management of state owned assets;

corporatisation; privatisation; classification of enterprises asstrategic; and the remuneration of company officers. The Ukrainelaw On Management of State Assets defines the broad range ofresponsibilities in governing the SOE sector, including policydevelopment, drafting of legislation, selection of governing bodiesand delegation (to them) of the functions in SOE management,monitoring and evaluation, as well as oversight.

A consolidation of these elements into a unified policy wouldallow Ukraine to be more specific about its objectives for the state-

owned sector as a whole. The Guidelines note that in order forgovernments to clearly position themselves as an owner, theyshould clarify and prioritise their objectives. Setting objectivesmay include trade-offs, for example between shareholder value,public service and strategic priorities. The ownership policy willideally go further than specifying the main objectives as an owner;also indicating its priorities and clarifying how inherent trade-offsshall be handled.

In the Ukraine context, an ownership policy would also provide

a mechanism to more comprehensively examine how the widerange of corporate forms that exist might be rationalised orconsolidated through greater corporatisation and privatisation.


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Setting individual objectives for Antonov

While a consolidated ownership policy may not exist, per se,Ukraine still possesses the capacity through its existing policyframework to have the Cabinet set out high-level objectives forAntonov. In fact, in Ukraine, coming from a history of highlyplanned state ownership, formal ownership objectives representsthe default option. Industry planning is prevalent and SOEsrepresent a key tool of government in promoting their industry-wide policies.

In the case of Antonov a ten-year strategy (to 2020) has beenapproved by Cabinet for the Aviation sector that provides thebroad basis for establishing core objectives for Antonov at the

ownership unit level.

Improving the centralised (or coordinating) ownershipentity

Guideline II. D. The exercise of ownership rights should beclearly identified within the state administration. This may befacilitated by setting up a coordinating entity or more appropriately,

by the centralisation of the ownership function.

When reforming their SOE sector, OECD jurisdictions haveshown a preference for centralising the ownership function or, atthe least, coordinating the exercise of ownership rights through acentral agency. Centralisation helps in clarifying the ownershippolicy and its orientation, and ensures its more consistentimplementation. Centralisation also facilitates the accumulationof relevant competencies by organising pools of experts on keymatters, such as financial reporting or board nomination. Finally,centralisation is also an effective way to clearly separate theexercise of ownership functions from other activities performed by

the state, particularly market regulation and industrial policy.

The organisational structure of the governments ownershipentity should be designed to explicitly identify the mechanismsand procedures for channelling any political input from thegovernment or the parliament in the governance of SOEs. Themechanisms and procedures should be rules based, with a view to


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minimise the risk of paralysis of the ownership function andefficient management of enterprises.

Ukraine has some features identifiable with commonly agreedgood practices in ownership oversight. Ownership oversight ispartly centralised although there are still numerous ownershipbodies in place. In accordance with the Commercial Code, allSOEs are formally governed by the Cabinet. However, in practicethe Cabinet delegates its powers and functions to relevantMinistries. The most common functions exercised by thesedelegated ownership units in Ukraine are related to thedevelopment of sector policy, appointment of companymanagement, review and approval of company financial plans,and evaluation of company performance.

The distribution of mandates and functions between differentgovernment bodies means there is no single government entitywith full oversight of the SOE sector and oversight responsibilitiesare spread across a number of government ministries andagencies. The State Property Fund (SPF) manages all stateenterprises undergoing privatisation and also has someresponsibility to oversee enterprises that have been corporatised.Key strategic firms remain under direct responsibility of theCabinet of Ministers. Other state-owned enterprises (primarilyunitary SOEs) are under the control of ministries and otherbodies, which can grant SOE status, reorganise and liquidatestate property, and appoint the management independently.

Reducing ownership entity involvement in day-to-daymanagement

Guideline II.B. The government should not be involved in theday-to-day management of SOEs and allow them full operationalautonomy to achieve their defined objectives.

In the case of Antonov, all of the entities within the group aresupervised by a newly created entity called the State Agency forManagement of the State Corporate Rights and Asset Management(State Agency for Corporate Rights). The State Agency forCorporate Rights is subordinated directly to the Cabinet of


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Ministers as a central executive body. The State Agency wascreated after the dissolution of the Ministry for Industrial Policyand has assumed the ownership rights from this Ministry. It

manages the ownership of 346 separate SOEs.

The biggest governance issue facing SOEs, and Antonov inparticular, is the extent to which the company is given thediscretion to function. According to discussions with the StateAgency for Corporate Rights it is significantly involved in theoperations of Antonov, although it was clear to stress that itsfunctions in terms of management were limited to makingrecommendations: it was clear that it could not directly interferein the operations of Antonov as a matter of law. The State Agencysaw its main tasks as:

Supervising management, both in terms of their operationsand the financial activities;

Appointing the Director-General (under a performance-based contract);

Monitoring day-to-day performance; Facilitating financing for the enterprise, including approving

any loans (in collaboration with the Ministry of Finance).This is a significantly more interventionist approach to

ownership supervision than would be recommended by the OECDGuidelines, which are predicated on ownership units appointingqualified boards to SOEs and letting these boards exercise theirresponsibilities and respecting their independence.

In the absence of a recognised external board, it is probablythe case that the ownership unit has felt it necessary to take amore hands-on role to oversight than would normally be the case.

(One member of the State Agency for Corporate Rights describedtheir role as analogous to the board of the company). While theownership role of the State Agency for Corporate Rights is afundamental element of Antonovs governance, it is no substitutefor a separate board. As noted earlier, there would be significant

advantages in terms of the level and quality of overview that a


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strong and experienced board would bring to the governance ofAntonov.

Exercise of key ownership responsibilities should bestrengthened

Guideline II.F. The state as an active owner should exerciseits ownership rights according to the legal structure of eachcompany. Its prime responsibilities include:

Being represented at the general shareholders meetings andvoting shares.

Establishing well-structured and transparent boardnomination processes and actively participating in thenomination of all SOEs boards.

Setting up reporting systems allowing regular monitoringand assessment of SOE performance.

Ensuring that remuneration schemes for SOE boardmembers foster the long-term interest of the company andcan attract and motivate qualified professionals.

The approach of the OECD Guidelines is that, while an

autonomous and independent board of directors

a corporate governance assessment of ukraine's state-owned aviation sector

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