Andriy Boytsun: What President Biden (and Other Western Leaders) Need to Know About Reform in Ukraine

Andriy Boytsun,  August 30, 2021

Western Support and Leverage

For decades, Ukraine has been engaged in a strategic partnership with the West aimed at promoting deep structural reforms. At times Ukraine’s leaders have been honest partners in this effort, sometimes they have been dragged reluctantly, and at other times they have offered determined resistance.

As a democratic country currently facing external military aggression, partial Russian occupation, economic difficulties, and a large debt burden, Ukraine cannot do without significant US and Western support. As a result, Ukraine’s economic dependence on aid and diplomatic support has created great leverage on the part of the Euro-Atlantic community, which the West has exploited to prompt reforms.

President Biden himself has a long, even impassioned, record of support and nudging of Ukraine down the bumpy road of reform. Similarly, following the signing of the EU-Ukraine Association Agreement, the European Union has been a staunch supporter of Ukrainian civil society, anti-corruption measures, and the rule of law.

While this dynamic has often driven important progress, at other times, Ukraine has had to acquiesce to poorly conceived or poorly executed reforms designed in Washington or Brussels. Such programs are often implemented in coordination with Ukrainian NGOs, which themselves have limited room for independent action as they, too, rely on Western aid and donor support.

Ultimately, this means that the success or failure of reform is often dependent on Western reform strategies with a mixed record. When real and measurable advancements are made, all is well and good. Yet, when setbacks occur, who then is to blame? The public and Western governments too often are quick to blame Ukrainian leadership, citing a stubborn corporate culture plagued by corruption, influential oligarchs, and murky business dealings.

For the sake of fairness, created by the poor track record of successive Ukrainian leaderships, this expectation is certainly not groundless. However, it should not be automatic. With the Ukrainian corporate governance reform once again in the headlines, and a part of the forthcoming summit between Presidents Biden and Zelensky, Western leaders also ought to recognize the shortcomings of their own involvement in the reform as a key variable in the equation.

SOE Reform

Following the Maidan Revolution of 2014, the West and Ukraine’s leaders agreed to tackle the problem of Ukraine’s large array of state-owned enterprises (SOEs), which for many years were a den of massive corruption and mismanagement, resulting in billions of dollars in losses to the state.

The corporate governance of Ukrainian SOEs started with Naftogaz, the state oil and gas champion and Ukraine’s largest SOE, initiating and pioneering the change in 2014. I am proud to have been part of this initiative from the onset. The international community joined in the effort in early 2015, and an independent supervisory board – the first-ever in a Ukrainian SOE – was established at Naftogaz in early 2016.

In parallel, Ukraine agreed that state-owned companies would be governed by supervisory boards in which the majority of seats would be held by independent members, sourced through transparent, competitive, and merit-based procedures.

Long sustained with massive state subsidies, Naftogaz became the leader in deep reforms. Its executives, appointed in 2014, and the new independent supervisory board, established in 2016, delivered impactful changes which turned the company around, improved its performance, and brought billions of dollars of profits to the state, assisting in filling the state budget and eliminating massive corrupt revenue flows to oligarchs.

The 2016 board was adamant in demanding proper and sustainable corporate governance reform. However, it was not able to come to terms with the government at the time, which itself was extremely reluctant to relinquish its nearly manual control over SOEs. In protest, the board’s independent members resigned in 2017.

Over time, Naftogaz’s role as a leader in best practices began to erode. It began to change after a new supervisory board was appointed in late 2017. The selections were made in haste and did not follow a competitive or transparent process. Instead, candidates were appointed via closed-door consultations between the government and a handful of foreign embassies and international partners.

Importantly, the process was not overseen by the SOE Nomination Committee or supported by a reputable executive search company. In that respect, it did not follow the OECD Guidelines on Corporate Governance of SOEs, a standard which the international community continues to uphold as a requirement.

Corporate Governance Failings at Naftogaz

Initially, the new board functioned as intended. Over time, however, the well-remunerated board (its chair receives around $285,000, while independent members are compensated at about $237,000 annually for their part-time supervisory role) became enmeshed with the executive leadership, providing generous bonuses to management and overlooking worrying signals that the corporate targets and projected profits were not being met.

The dysfunction of the board became evident in the controversial decisions it made in 2020. That year, instead of delivering on a projected $400 million profit fueled by an increase in gas prices at the end of the year, Naftogaz delivered losses of nearly $700 million. Despite this outcome, executives were paid out multimillion bonuses. Naftogaz chose not to disclose individual executives’ remuneration in 2020, despite doing so in 2019. This apparent lack of transparency has led to accusations that the supervisory board deliberately concealed information from the public.

In response to Naftogaz’s underperformance, the Ukrainian government, acting as a concerned shareholder at its annual meeting, temporarily suspended the board to dismiss the company’s CEO Andriy Kobolyev and replace him with Yuriy Vitrenko.

In return, US and G7 officials, as well as representatives of international financial institutions, declared that the leadership change violated best practices and Ukraine’s obligations under SOE corporate governance reform. Indeed, while the Ukrainian government’s action was within Ukrainian law, it was certainly not in line with the OECD SOE Guidelines.

Due to international criticism, the government kept the current board. The Prime Minister even offered to add a “US representative” to the Naftogaz board and an “EU representative” to the SOE Nomination Committee. This suggests that Ukraine’s authorities may troublingly see the international community as a set of constituencies each promoting their own interests rather than a well-meaning partner advocating a transparent nomination process, the OECD standards, or, more generally, better rules in Ukraine.

Under protection of the international community, the board doubled down in another controversial act in June 2021, approving a further package of multimillion dollar bonuses to top management – in the middle of the year, well before results were announced, and over the objection of the company’s new CEO.

The Role of the International Community

Not surprisingly, the role of the international community in the board’s performance has resulted in a growing mistrust towards foreign influence in Ukrainian institutions. Mistakes on the part of both Ukraine’s previous government and key Western partners were unfairly blamed solely upon Ukrainian leadership. And Naftogaz’s most critical stakeholder – the Ukrainian public – has suffered for it.

The June 7^th statement on the phone call held between Presidents Biden and Zelensky noted that the leaders discussed Ukraine’s “plan to tackle corruption and implement a reform agenda, based on our shared democratic values and Ukraine’s Euro-Atlantic aspirations, that delivers justice, security, and prosperity to the people of Ukraine.”

It is likely that the forthcoming summit will echo the same sentiment. What should be added to the agenda, however, is the recognition of the shared responsibility for Naftogaz and its board’s performance.

Importantly, the 2017 “deal” on the Naftogaz supervisory board was made between the international community and the country’s previous leadership, who bears even more responsibility. Ukraine’s current leadership may then find itself in the precarious position of engaging with its international partners who not only have their fingerprints on the matter, but continue to focus on it as an inherently Ukrainian impediment to its own progress.

In this instance, the international community’s silence over the (under)performance of Naftogaz is harmful to Ukraine’s interest. This idea is, at best, inconsistent with OECD standards and, at worst, can be dangerously construed as being consistent with the concept of “external management” of an independent country and its vital state enterprises.

What Next?

Given Ukraine’s ongoing dependence on Western support, the country’s leaders quietly listened to the criticism that was not entirely founded. Moving forward, the US and other democratic allies of Ukraine should rightfully acknowledge that something went wrong with the governance of Naftogaz, and, critically, work with the company to make the necessary corrective measures to get back on track.

Specifically, if we all want the Naftogaz board – and the boards of all other Ukrainian SOEs – to be truly independent, one must start to think differently and abandon the idea of foreign board members as country “representatives.” It is a concept that critics dismiss as infringing upon Ukrainian sovereignty.

This starts with acknowledging the right and obligation of the state to “act as an informed and active owner, ensuring that the governance of SOEs is carried out in a transparent and accountable manner” in the interest of the country’s citizens as the ultimate beneficiaries of these SOEs – an important basic principle of the OECD SOE Guidelines. Further, with a new board elected via a transparent process in accordance with the OECD SOE Guidelines, Naftogaz can be restored as the bellwether of Ukraine’s corporate governance reform.

Ultimately, the West has great strategic interest in adopting some new thinking about supporting the country (and Naftogaz) to ensure that it becomes a strong, independent, European partner and ally. Helping to set up a transparent, competitive, and merit-based process to select an independent supervisory board at Naftogaz is an excellent first step.

Andriy Boytsun is the Lead of the Corporate Governance Stream at the Kyiv School of Economics. He designed the corporate governance reform of Naftogaz in 2014-2015, advised large SOEs and governments, and drafted Ukraine’s corporate governance law. Andriy leads the team that publishes the Ukrainian SOE Weekly, a digest on state-owned enterprises in Ukraine. He holds a PhD from the University of Antwerp, with a thesis on corporate governance.

* The Foreign Policy Association does not take positions, the views of the author are his own.