Chapter 4. Ukraine and the OECD National Treatment instrument1

Privatisations

The 1992 privatisation law prohibits investment in the privatisation of state and municipal property by companies that are more than 25% equity-owned by a state,2 including by foreign states. Based on this provision, many top European telecom companies that had to various degrees expressed interest in the fixed-line telecommunication incumbent Ukrtelecom – including Deutsche Telekom and Norway’s Telenor – were barred from participating in bids for privatisation in 2010. There are, however, no restrictions on the resale of privatised shares by residents to non-residents or established foreign-controlled enterprises on the secondary market.

Access to agricultural land and forestry

According to the Land Code, foreign individuals, foreign legal entities and subsidiaries of foreign companies (Ukrainian legal entities with foreign investment) are not allowed to own agricultural land but they may acquire non-agricultural land plots only if they already own, buy or will build real estate on such land (OECD, 2015). For instance, they can own non-agricultural land for purposes related to agriculture, such as agro-processing located further away from the growing area, but only as an adjunct to purchasing non-movable assets located on said land. This discourages investment as the purchase of or building a factory creates a right to own land, and not the other way around. If non-agricultural land plots become agricultural land, foreign legal entities and fully owned subsidiaries of foreign companies would have to sell them within one year.

If foreigners, a foreign legal entity or subsidiaries of foreign companies (joint-ventures with participation of foreigners and foreign legal entities) wish to purchase state-owned non-agricultural land, a complicated process is prescribed in the Land Code3 and requires ultimate consent by the Cabinet of Ministers in addition to prior approval by relevant Ministries (this process does not exist for sales of private non-agricultural land).

Only Ukrainian citizens and legal entities can own forests. Foreign legal entities and subsidiaries of foreign companies (Ukrainian legal entities with foreign investment) are not authorised to own forests. In practice, forests are state-owned: the State Forestry Agency manages 68% of forests, with the remaining 32% spread across approximately 50 public agencies, local municipalities, and educational organisations (OECD, 2015).

Access to government purchasing

Ukraine’s framework regulating public procurement is open to foreign and domestic economic operators on an equal basis, unless bidders are from off-shore zones (e.g. the Bahamas, Belize, the British Islands, the Cayman Islands, etc.), as defined by Ordinance No. 143-p of the Cabinet of Ministers (23 February 2011). Details of the grounds for rejecting foreign companies registered in off-shore zones are provided for in Article 17 of the 2014 Law on Public Procurement. Specifically, according to paragraph 3 of alinea 2 of this Article, participation by firms registered offshore is forbidden. Reportedly, this provision has been enacted for the purpose of targeting companies that in this way avoid taxes and should be deemed as such having outstanding tax liabilities, which prevent them from becoming parties to public contracts. As such, this provision most likely refers to off-shore companies established by Ukrainians; however the way it has been drafted allows for a broader interpretation and rejecting any foreign companies that may be suspected in taking advantage of low taxation countries.

Media and news agencies

The Law “On Television and Radio Broadcasting”4 forbids foreign legal entities, individual entrepreneurs or any non-resident registered in offshore zones (as defined by the Cabinet of Ministers) from setting up or being shareholders or co-founder of TV channels, radio broadcasting companies, or television and radio content providers. The national television and radio broadcasting council of Ukraine ensure that broadcasting organisations comply with legislative requirements, include requirements regarding foreign investments in their share capital.

According to the Law “On news agencies”,5 news agencies can be created only by Ukrainian citizens and Ukrainian legal entities. Foreigners and foreign legal entities can be co-founders of news agencies (with Ukrainian citizens or legal entities), but the share of foreign ownership is limited to 35% of the charter capital. Foreign news agencies can set up representative offices in Ukraine.

There are no ownership restrictions on foreign ownership or investments in the telecoms and internet sectors.

Domestic and international air transportation

Foreign airlines can set up affiliates in Ukraine and operate domestic flights under certain conditions (including reciprocity conditions) defined by the international agreements that Ukraine concluded in the sphere of civil aviation. Several affiliates of foreign airlines have been operating domestic flights in recent years.6 However, a recent regulation of the civil aviation authority stipulates that, as of July 2016, licences for international regular and charter air routes will be reserved to airlines that are directly or indirectly majority-owned (more than 50% of the share capital) by Ukrainian citizens or the Ukrainian state.7 This restriction is not applicable to licenses for international air routes granted by foreign civil aviation authorities under Ukraine’s international civil aviation agreements. According to Ukrainian civil aviation authorities, this restriction is required to harmonise Ukraine’s civil aviation rules with EU Standards, in the perspective of the conclusion of a comprehensive EU-Ukraine aviation agreement. Chaper 3 gives more details on this agreement, which is still being negotiated.

Cabotage

Cabotage transportation (i.e. between Ukrainian ports, including as part of international transportation) is reserved to vessels under the Ukrainian flag.8 However, if there is a permit issued by the State Inspectorate of Safety at Maritime and River Transport, it is possible to sail under the flag of another country. The right to fly the Ukrainian flag belong to ships owned by Ukrainian citizens or Ukrainian legal entities whose shareholders are all Ukrainian citizens. It also belongs to ships that Ukrainian citizens rent under a bareboat charter arrangement.

Concerns with national security

Since the last review of Ukraine in 2011, the country has amended its policies in this area or introduced new legislation to address national security concerns in the context of foreign investment. This policy-making activity has been in part driven by a re-evaluation of what national security encompasses and in which ways it can be threatened, as demonstrated by the adoption of a new Strategy of National Security of Ukraine in 2015.9 Pursuant to the strategy, “limitations aimed at preventing the penetration of capital from the Aggressor-state10 in strategic sectors of the economy” are necessary in order to ensure the economic security of Ukraine.11

Ukraine has defined circumstances under which a national security exception can be invoked in its Law “On Fundamentals of National Security of Ukraine”.12Although the list of “potential and real economic threats to the national security of Ukraine” (Article 7) is rather broad, the factors the regulatory or legislative authorities may proceed from to ban or scrutinize foreign investment shed some light on what is to be covered under the Ukrainian concept of threats to national security:

• An increase in the share of foreign capital in strategic sectors13 of the Ukrainian economy such that it jeopardises Ukraine’s economic independence;

• Critical dependence of the national economy on the business cycles of international markets and a low rate of expansion of the internal market;

• A significant reduction in GDP, investments and research activities in key sectors of scientific and technological development;

• The weakening of state regulation and control regarding the economy;

• The instability of regulations in the economic sphere, including the government’s fiscal policy as well as the absence of an effective programme for the prevention of financial crises and the increase of credit risks;

• The critical state of basic production assets in the leading industrial sectors, in the agro-industrial complex and regarding technical maintenance of nuclear power installations;

• Insufficient economic growth and the structural misbalances in the economy;

• An exports structure composed mainly of raw materials and containing few high added value products;

• The high level of internal and external government debt;

• Inadequate anti-trust policy and inadequate regulation of local monopolies that prevent the creation of a competitive economic environment;

• The critical situation regarding the population’s supply of food;

• The ineffective use of fuel and energy resources, an insufficient diversification for their supply and the absence of an effective energy-saving strategy;

• The “Black” or “Shadow Economy”;

• A predisposition at the top level of the public service to favour individual, corporate and regional economic interests over national priorities.

Although this list may been seen as giving broad discretion to Ukrainian authorities in deciding whether a particular foreign investment threatens national security, Ukraine has, in general, maintained an open policy towards foreign investment, including in sectors that are often considered as national security sensitive. If some strategic sectors are barred to investment, such prohibition most often applies equally to domestic and foreign investors.14 Furthermore, the 2015 Strategy of National Security of Ukraine,15 while considering that “limitations aimed at preventing the penetration of capital from an “Agressor-state”16 in strategic sectors of the economy” are necessary in order to ensure Ukraine’s economic security, also recognizes “foreign investments in key sectors of the economy, including energy and transports” as a key contribution to it. Contrarily to previous versions, the 2015 Strategy contains no general mention to “foreign investments in strategic sectors” as a potential threat to national security.

National security grounded approaches to foreign investments

Ukraine’s response to national security concerns stemming from foreign investment has taken two distinct forms: partial or total prohibitions of foreign investment in specified sectors and sector-specific licensing provisions.

Total or partial prohibitions of foreign investment in specific sectors

Ukraine retains prohibitions of any foreign investment on national security grounds in the manufacturing of weapons and in space facilities,17 as well as for certain categories of investors in TV and radiobroadcasting. With regards to the latter sector of activities, legal entities and residents, as well Ukrainian legal entities whose shareholders or ultimate beneficiaries are residents from an “Aggressor-State”, are forbidden from setting up or being shareholders of any TV or radio broadcasting company, or of any television and radio content provider.18

As noted above, the 1992 privatisation law also prohibits investment in the privatisation of state and municipal property by companies that are more than 25% equity-owned by a foreign state but there is no indication in the legislation that this restriction aim at managing risks related to national security. However, the government is preparing amendments to the Privatisation Law in order to limit the scope of this restriction to Ukrainian SOEs. If these amendment are adopted, foreign SOEs (or foreign companies where a state owns more than 25% of the share capital) would thus be allowed to take part in privatisations. By contrast, the government introduced a draft law prohibiting legal entities and citizens from the Aggressor-State, as well as Ukrainian legal entities whose shareholders or ultimate beneficiaries are residents from the Aggressor-State, from taking part in the privatisation programme.19

Legal entities and residents, as well Ukrainian legal entities whose shareholders or ultimate beneficiaries are residents from the Aggressor-State, are forbidden from setting up or being shareholders of any TV or radio broadcasting company, or of any television and radio content provider.20

Sector-specific licensing provisions

Under the Law of Ukraine “On Licensing Types of Economic Activity”21 (hereinafter – the “licensing Law”), 30 economic sectors require prior government authorization (i.e. an activity licence), which can be denied on national security grounds. The essence of this approval process can be summarised as follows: entities “under the control of residents from countries undertaking armed aggression against Ukraine and/or creating conditions for armed conflict or use of military force against Ukraine” are not entitled to an activity license in these sectors.22 The licensing authority is usually a government agency in charge of sector-specific regulation (often named “National Commission”). This provision applies to all of the 30 economic activities subject to licensing, except for banking activity and activity in the areas of television and radio broadcasting, production and trade of alcoholic beverages and tobacco products.23 The basis for refusing to grant a license is documentary evidence of control of “residents from countries undertaking armed aggression against Ukraine and/or creating conditions for armed conflict or use of military force against Ukraine” (hereinafter “residents from countries undertaking armed aggression against Ukraine, etc.”), to be established by licensing authorities. The licensing law, under the same provision, also provides the grounds for cancellation of existing licenses held by such entities.

The licensing law gives an extensive but rather vague definition of control, which includes “decisive influence” over a business entity, and does not define a precise shareholding threshold or clarification regarding the exact interpretation of control in the context of the licensing law. As a result, regulatory authorities have applied the law unevenly. For example, on 24 June, 2015 the National Securities and the Stock Market Commission (NSSMC) cancelled the brokering licenses of 7 market participants with Russian capital (among which the banks Sberbank and VTB) on the basis of documentary evidence of control of “residents from countries undertaking armed aggression against Ukraine, etc.”24 It did not however cancel the brokering license of Alfa Bank Ukraine, which belongs to Russian Alfa Group but is formally controlled by a Special Purpose Entity (SPE) based in Cyprus.25 On 6 October 2015, the NCSSM cancelled the license of PFTS, one of the largest stock exchanges in the country; because of documentary evidence of control of “residents from countries undertaking armed aggression against Ukraine, etc.” (Moscow Stock Exchange had a majority stake in PFTS). This suggests that some licensing authorities may have adopted a formal definition of “Aggressor control”, i.e. direct control by a foreign entity or individual.

Professional and other services

Ukraine’s legislation imposes a Ukrainian nationality requirement for notary services.26 As this measure concerns natural persons, it is not taken into account in the list of measures qualifying for exceptions to national treatment in the meaning of the OECD Declaration on International Investment and Multinational Enterprises given that the scope of the OECD National Treatment instrument covers legal entities only.

The director of primary and secondary education institutions, both public and private, shall be a citizen of Ukraine, having a degree in Pedagogy and not less than three years of experience in teaching.27 The same requirement applies to all pre-school and non-school education institutions (public or private alike).28 The heads of State or municipal higher education institutions shall be Ukrainian citizens.29

Repatriation of foreign investment

Article 397 of the Economic Code of Ukraine and Article 12 of the Law of Ukraine “On the Foreign Investment Regime” guarantee free transfer of returns, profits and others funds received by foreign investors as a result of foreign investment. In addition, in accordance with Article 5 of the Order of the Cabinet of Ministers of Ukraine “On the system of foreign exchange regulation and foreign exchange control”, there is no obligation to secure authorization in order to repatriate foreign investment, or profits and other funds earned as a result of investment. In addition, in the territory of Ukraine, a foreign investor may invest funds from investment accounts opened with authorized banks both in authorized foreign currencies and in Hryvnia.30

In recent years, as Ukraine faced negative and unpredictable external conditions, the National Bank of Ukraine (NBU) adopted a range of temporary capital control measures to address external imbalances, to tame panic in the foreign exchange market, and to stabilize disorderly market developments. In 2009-10, foreign investors were obliged to route their monetary contribution in foreign currency exclusively through “investment accounts” opened with Ukrainian banks.31 In March 2015, currency controls were tightened by broadening and extending prohibition of certain foreign currency transactions.32 Banks are subject to the obligation to monitor foreign currency purchase transactions on a daily basis and service only those that have an express legal basis. The NBU is granted the right to suspend any transaction suspected by the NBU of being illegal and to request additional documents regarding such transactions. At the same time, in September 2015 and in December 2015, the NBU slightly relaxed some of its previously introduced restrictions, in particular:

• The cap on daily cash withdrawal from foreign exchange accounts have been raised to UAH 20 000 (about USD 939) from UAH 15 000 (USD 704).

• The prohibition for Ukrainian banks to purchase foreign exchange funds upon instructions of their clients (other than private individuals) if such clients already hold FX funds in a Ukrainian bank account has been relaxed for certain non-convertible currencies (Egyptian pound, etc.).

• In December 2015, the NBU relaxed the 75 % mandatory sale (surrender requirement) of foreign currency in the case a resident borrower uses it to fulfil its obligation under an import contract involving a foreign export credit agency.

These changes should not influence significantly the foreign currency market (for a detailed analysis, see UkrSibbank Research, 2015).

Several temporary capital control measures introduced in 2015 directly impact foreign direct investors established in Ukraine, including the prohibition of the following foreign-exchange transactions:

• Transfers of dividends to foreign investors;

• Repatriation of the proceeds from the sale of a security, except in the case of a debt security sold on a stock exchange (NBU verifications required in this case) or in the case of government bonds;

• Repatriation of the proceeds from the sale of corporate rights (other than shares), from the decrease of the charter capital or the withdrawal of a foreign shareholder in a company;

• Prepayments under foreign loans, including if repayments are shifted to earlier dates.33

The National Bank of Ukraine has been considering further liberalization steps conditional upon sustained improvements on the foreign exchange market and of the general economic situation.34

Monopolies

The Ukrainian legislation defines a natural monopoly as an activity in which the absence of competition is beneficial to the market due to specific features of production, and products cannot be replaced by equivalent substitutes.35 The law classifies the following activities as natural monopolies (Article 5):

• Transport of oil and oil products by oil pipelines;

• Transport of natural gas and oil gas by pipelines;

• Distribution of natural gas by pipelines;

• Storage of natural gas beyond certain volumes defined by the Ukrainian legislation;

• Transport of other products by pipelines;

• Transmission and distribution of electricity;

• The use of railway lines, dispatcher services, railway stations and other rail infrastructure;

• Air traffic control;

• Centralised supply and distribution of water;

• Centralised heating supply;

• Specialised services in ports and airports, as determined by the Cabinet of Ministers;

• Burial of domestic waste.

The law also defines “adjacent markets” as markets closely related to natural monopolies, since market participants directly rely on products produced or sold by natural monopolies for their own activities. The law classifies the following activities as “adjacent markets” (Article 6):

• Supply of any product transported by pipelines, including natural gas;

• Domestic and international transport of passengers and cargo by rail, air, sea or rivers;

• Production and supply of electricity;

• Processing of domestic waste;

• Sale of natural gas beyond certain volumes defined by the Ukrainian legislation.

According to the law, natural monopoly can be state-owned or private entities, provided that they comply with applicable regulations.

Natural monopoly activities and activities on “adjacent markets” (as defined above) are subject to licensing. The Licensing authorities can be either National Commissions (sector-specific regulators) or Ministries. In the case of regional or local monopolies, local governments are entitled to regulate them and act as licensing authorities. In practice, one prominent licensing authority is the National Commission for State Regulation of Energy and Utilities, in charge of the regulation of the power sector (electricity, natural gas, heating supply), along with centralised supply and distribution of water and domestic waste.36 The Ministry of infrastructure is the Licensing authority and regulator in the field of transport and transport infrastructure (including ports and airports). According to the law (Articles 8 and 14), licensing authorities of natural monopolies enjoy wide regulatory powers, among which the fixation of tariffs and the regulation of consumer’s access to the products of natural monopoly, and the determination of compulsory quality standards. The law stipulates that regulatory procedures should be transparent and open.

The Antimonopoly Committee of Ukraine maintains an overall record of natural monopolies.37 According to this record, as of January 2016, 6 natural monopolies (all state-owned) operated at the national level:

• Air traffic control services: state enterprise Ukraerorukh (report to the Ministry of Infrastructure);

• Railways, dispatcher services, railway stations and other rail infrastructure: state administration of Ukraine’s railway transport Ukrzalinitsya;

• Transport of natural gas by pipelines: national shareholding company Naftogaz represented by its subsidiary Ukrtransgas;

• Transport of oil and oil products by major pipelines: national shareholding company Naftogaz represented by the open joint stock company Ukrtransnafta;

• Transmission of electricity via national and international electricity grids: state enterprise National Energy Company Ukrenergo.

In Ukraine, the production of ethyl alcohol is a state monopoly.38 The State-owned holding Ukrspirt was created in 2010 to reunite 40 state-owned ethyl alcohol factories. Although it is not on the list of the SOEs subject to privatization in 2015,39 the government signalled recently introduced a draft law40 that would allow a partial or total privatisation of Ukrspirt in the future.

According to the Law “On Postal services”,41 the national state-owned operator “Ukrpochta” has an exclusive right to the publication and distribution of stamps and the conveyance of ordinary postcards and ordinary letters up to 50 kilogrammes. The handling of parcels and letters of more than 50 kilogrammes is thus open to the private sector. It is subject to a licensing system and tariff regulation by the National Commission for State Regulation of Communications and Informatisation (NCCIR). This tariff regulation is limited to universal postal service obligations (which extends to letters and parcels up to 10 kilogrammes).42

In addition, a list of “State assets of strategic importance for the economy and national security” sets forth the strategic enterprises under Ukrainian government control. In 2015, under this list, the number of strategic state-owned enterprises was reduced to 309.43 This list is to be updated and might be reduced further in the future. It comprises strategic state-owned enterprises in the energetic sector (such as Naftogaz and Energoatom), transport infrastructures such as the Kyiv International Airport and key commercial ports, aerospace and rocket companies in the defence sector, etc. The Prime Minister announced that these strategic state-owned enterprises would not be part of the privatisation program.

Concessions

Ukraine’s legislation on concessions entails multiple normative acts, which makes the Public private partnerships (PPPs) framework relatively complex. The Law “On Public-Private Partnership” stipulates that foreign investors can participate in public-private partnerships, defined as co-operation between the State of Ukraine and territorial communities and, on the other side, private businesses or individual entrepreneurs.44 Such co-operation can take the form of a concession, production sharing agreement or joint activities. The law defines general principles of PPP projects, in particular a fair allocation of risks and access to land plots. Public private partnership agreements are concluded for a period of five to 50 years. Under the law, PPPs are possible in the following economic sectors:

• Exploration, prospecting of mineral deposits and production thereof;

• Heat production, transport and supply, and natural gas distribution and supply;

• Construction and/or operation of highways, roads, railroads, runways at airports, bridges, overhead roads, tunnels and subways, river and sea ports and infrastructures thereof;

• Machine building;

• Water collection, purification and distribution;

• Health care;

• Tourism, leisure, recreation, culture and sports;

• Support of operation of irrigation and land improvement systems;

• Waste treatment and management;

• Electric power production, distribution and supply;

• Property management.

The 1999 law “on Concessions” refers to a narrower definition of PPP as “the transfer for a defined period of time by a public entity (state or territorial) of the right to create or/and operate an object to private investors on the basis of a concession agreement”.45 The Law defines key legal principles applicable to concessions, as well as conditions of and procedure for conducting concession tenders. It stipulates that individuals and business entities, both resident and non-resident, can bid for concessions and establishes the possibility to lease state and municipal property for up to fifty years for the purpose of concession arrangements. In addition to the economic sectors mentioned above,46 state or municipal assets are eligible for concession agreement in the following sectors:

• Urban public transport and municipal parking services;

• Telecommunications;

• Postal services;

• Public catering;

• Construction of residential real estate;

• Funeral services.

The regulatory framework and recent developments of PPPs in Ukraine is detailed further in Chaper 3 (Infrastructures and Financial Sector Development).