Concorde Capital: Ukrainian corporate governance, from ape to man

By bne IntelliNews February 27, 2007

Concorde Capital in Kyiv -

Ukraine is going through a transformation driven by the rapid development of the economy, says Kyiv-based Concorde Capital. One of Ukraine's leading investment banks, Concorde highlights two developments that are currently shaping Ukraine’s business climate in a comprehensive report detailing the evolution of Ukraine's corporate governance: from ape to man.

On one side, the new economy has strengthened enough to become a significant force. A new generation of business owners is coming into the spotlight. People who started their new ventures in the late 1990s, early 2000s want to capitalize on their successful businesses. Their new more "self-made" background is instilled in their management and a new approach to capital markets is becoming the norm. "Red directors" are increasingly becoming a relic of the old epoch.

On the other side, new political realities and the maturing market suggest a new quality of money is starting to flow into Ukrainian equities. This money is more demanding. It wants not only to know about a company’s business affairs, but also has a thirst for information about how the company is managed.

Between 2004 and 2006 the Ukrainian market grew by leaps and bounds, with increasing liquidity. The PFTS stock index has smashed through one historical maximum after another and found a new comfort zone well above the 500 mark since the beginning of 2007. The number of private placements and IPOs completed in 2006 was four to five times greater than 2005. The number and size of new equity offerings scheduled to take place in 2007 should make 2006’s numbers pale in comparison. This widening and maturing of the market, with new stocks on the supply side and new investors on the demand side, raise the need for more detailed information concerning corporate governance.

Where Are We On The Darwin Scale?

On the whole, Ukrainian companies are still far behind their Western peers in terms of corporate development, most have never considered formulating a corporate strategy, the management feels uncomfortable facing simple questions from experienced shareholders. Ownership is generally highly concentrated, which does not facilitate the development of higher business standards. The supervisory boards of most companies are nothing more than rubber-stamp committees for the beneficial owner.

Of crucial importance is that the current legal system does not promote high corporate governance standards. Law provisions are formulated so loosely that publishing something like, “Hey, last year was great”, in a newspaper would likely meet all requirements. Timely and non-discriminatory dissemination of information is rare and the official publications where companies are required to publish their information are very primitive in quality.

Ownership structure is only made public to a certain degree, (ie. beneficial owners are generally cleverly hidden in order to protect their business from legal attacks from rivals), making getting detailed information about ownership plans and motivation a chore. Legal requirements are patchy and most companies can stay within the parameters of the law and reveal very little.

The bulk of companies either have no websites or websites that contain little information of interest to shareholders and are rarely updated.

A ray of light in this opaqueness is the memorandums at bond issuances, even local placements: they contain plenty of valuable information, thanks to the demanding nature of the regulations.

The arrival of the Tymoshenko government in 2005 sent shockwaves through the business community and led many companies and business groups to improve their corporate governance in order to forge closer ties with western financial institutions and thus protect themselves from possible hostile moves by the government. Despite the fall of the “Orange Crusaders,” many companies thereafter found attracting capital on western markets a much easier and cheaper alternative to more shady local forms of financing and continue to make strides towards the development of a corporate idea.

Moreover, in 2006 a new law regulating the activities on capital markets brought Ukraine’s legislation another step closer to contemporary standards.

Ukrainian Corporate Governance: Our Approach

One of the goals of this report is to share our knowledge and experience in dealing with local companies to shed light on the corporate governance standards behind the numbers to help investors make more informed investment decisions.

Unlike Russia, in Ukraine systematic analysis of corporate governance practices is scarce, especially from the point of view of a portfolio investor. In fact a recent study of corporate governance by Standard & Poor’s for thirty Ukrainian banks is about the only attempt made to tackle this issue. In order to fill the gap we are publishing our first report on Ukrainian Corporate Governance.

We limit the scope of our research to several key areas, not venturing into the stringent requirements of an international Corporate Governance examination, which generally includes analysis of aspects such as management committees and supervisory boards, decision making processes, accountability of the management and internal company regulations. When placed alongside other aspects of corporate governance, these are the least developed in Ukraine.

The relevant information is accessible in very rare cases, and we would encounter difficulties trying to differentiate companies in theses areas. For this reason we focus on aspects which in today’s environment are more important for decision making while investing into Ukrainian equities. Specifically taking into account that in recent years we have witnessed blatant disregard for minority rights in the form of massive dilutive share issues; many companies release financial reports sporadically that are often incomplete and management is unwilling to share their strategy with the investment community.

For these reasons we have decided to make Reporting & Disclosure, Investor Relations, Minority Concerns and Strategic Risks the focal point of our report.

Ratings Round-up

The most striking thing about corporate governance standards in Ukraine is how widely they vary. Companies listed on Western exchanges were by far the leaders in maintaining high standards while those with little or no experience in attracting foreign capital in some cases had never even heard of the term Corporate Governance. Sadly almost have the companies we looked at in this study received our lowest rating – Poor.

Foreign Guests. The oil & gas sector had some of the highest scores in our report, due in a large part to the presence of three foreign-based oil companies Cardinal Resources, JKX and Regal Petroleum. All three scored near the top of our ratings with near international corporate governance standards in terms of disclosure and investor relations.

Studying Abroad. Ukrainian companies that were part of a large international holding or had been listed on a foreign exchange also received high scores. Mittal Steel Kryvy Rig, Sun Interbrew, and Slavutich are examples of the first type, incorporating the business practices of the parent holding. While companies’ like Astarta and XXI Century, which chose the warmer climates of Warsaw and London, have brought their level of openness and transparency to near the standards of their adopted homeland.

Homegrown Heroes. Two of our top scorers were the smaller Ukrainian companies Bank Forum and Galnaftogaz. The companies are trailblazers in attracting foreign equity capital (both were among the first Ukrainian companies to make private equity placements among institutional investors).

Galnaftogaz has announced ambitious plans including an IPO, while Bank Forum used the funds from its placement to become one of Ukraine’s top ten largest banks in terms of assets and is currently in the process of a strategic sale. Thus it is little surprise that both are leaders when it comes to corporate governance.

Working For The Man. In the case of Ukrtelecom, and a few companies from the energy sector, state ownership did not result in poor corporate governance practice. In fact with UTEL while the risk of bad business decisions is still there, significant improvement in all other aspects is obvious - the company is being prepared for privatization. At Ukrnafta, even though the state’s majority share is de facto managed by Privat Group, the significance of the company and presence of state regulators on the board helped keep its corporate governance standards at a high level.

Monkey Business. Companies part of large Ukrainian business groups tended to have the lowest level of corporate governance standards. In most cases they are unwilling to share the most basic information and are leery of minorities. It is important to note that with several of these companies their holding companies, like Metinvest, for example, tend to be very accommodating. However, individual companies rarely ever provide the name of their holding.

Break Down By Sector

Some of Ukraine’s new booming sectors, like Consumer Goods and Financial Services raked in the higher scores in our survey while the traditional backbones on the economy showed that they had a lot of catching up to do.

Consumer Goods: Leaders Of The Pack. Consumer goods producers came out well above the rest of the sectors with a mean score of 6.9, about 1.0 point higher than the second highest scoring sector. High scores by the sugar producer Astarta (11.0), XXI Century (9.5) and the retail chain Velika Kesheniya (5.0), along with solid scores by the brewers Sun Interbrew (formerly Rogan) (5.0) and Slavutich (8.5) and dairy producer Ukrprodukt (5.0), all drove up the sector’s score while other scorers computer retailer MKS and Zhidachiv Paper got scores of 5.5 each. The presence of large international holding companies behind the brewers as well as the listing of XXI Century in London and Astarta in Warsaw support their strong ratings.

Financial Services: Good, We Thought They’d Be Better. The sector received the second highest average score 5.9, however, we expected to see banks with large foreign owners dominate the scoring. In fact, with the exception of Ukrsotsbank (with a score of 6.5) it was smaller local banks that had the stronger scores led by Bank Forum (9.0), Megabank (6.0), Ukrgazbank (5.5) and Rodovid Bank (5.0). While the media darling Raiffeisen Bank Aval’s score of 6.0, though also solid, failed to meet our expectations in terms of investor relations. Our findings turned out to be quite similar to that of a joint report by Standard & Poor’s of Ukraine’s top 30 largest banks from last December. In their rankings Raiffeisen Bank Aval finished near the bottom of the pack. Universalna Insurance (part of Universalna Group which includes Galnaftogaz) received a strong score of 6.0.

Oil & Gas: Bogged Down By Refineries. Despite being boosted by the inclusion of three foreign-based companies (Cardinal 10.0, JKX 9.0, Regal 9.0) whose openness to investors and past IPOs brought them high scores, Ukrnafta (6.5) and our top scorer Galnaftogaz (11.0), the sector came in way behind financial services with a score of 4.3. The shoddy scores received by the traded refineries (HNPK -8.5, HANZ -7.5) we included on the list pulled down the sector.

Metals & Mining: NITR & KSTL Head & Shoulders Above The Rest. As a sector, Metals & Mining had some of the lowest overall results in our research, however, Nyzhnoydniprovsky Pipe and Mittal Steel Kryvy Rig went against the grain to bring strong scores of 7.5 and 6.5 respectively. KSTL came as little surprise, as Mittal has spent its first year in control stomping out grey schemes with its traders and improving the plant’s efficiency. NITR despite being part of a large Ukrainian holding (generally a precursor to poor corporate governance) is a leader in terms of transparency and financial disclosure in the pipe sector. Other names that deserve mention are Khartzysk Pipe and Azovstal that received solid scores above 5.0 representing their greater focus on investor relations and good financial disclosure. The next highest score in the sector was 3.5, with the bulk of the companies receiving negative scores.

Best and worst

IPO Here We Go. Companies preparing to attract or with experience in attracting foreign investment go to great lengths to improve their level of corporate governance as a tool to woo investors. This was clearly reflected in our findings: companies that had completed an IPO or private placement had a mean overall score of 6.7, while companies that had announced plans had an average score of 4.6 and those with no plans had a meager mean score of 0.9. Several companies under the umbrella of IPO-bound Metinvest got our 0.5 score, while Bank Aval and Ukrsotsbank both received the highest possible score as both companies were recently bought by institutional investors and are clearly at a higher level, with no need for their new owners to be schooled in the art of using equity market tools.

P-R-I-V-A-T Spells Trouble. Companies that scored the lowest in our section on corporate conflicts were part of large Ukrainian business groups.

The biggest culprit was Privat Group: the better half of all poor scorers in our rating are associated with Privat. Companies that scored poorly in this section are involved in either internal power struggles involving rival business groups (including six Oblenergos - Ternopil, Poltava, Chernihiv, Sumy, Lviv, Prikarpattya along with DniproSpetsStal and Kievenergo), or with their minority shareholders (like Zaporizhstal), or with the government (NFER)).

Ukrnafta falls into this list due to the risks associated with possible changes to a law that would reduce quorum at AGMs from 60% to 50% which would with high probability lead to a messy power grab for control of the company.

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