7. Public Governance – Reducing Corruption and Mitigating Risk in the Energy Sector

Introduction

The quality of public governance significantly affects the business and investment climate in all economic sectors, including energy. Ukraine’s economy, and in particular its energy sector, have suffered for decades from systemic corruption that has reached the highest layers of Ukraine’s executive, legislative and judicial systems. Since Ukraine’s independence in 1991, corruption in the energy sector has had a central role in most of the political crises in the country (Kuzio, 2008[1]).

Ukraine’s “Revolution of Dignity” in 2014 has played the role of a “wake-up call” for Ukraine, urging the country to make concrete institutional and legislative changes to fight corruption and to increase Ukraine’s energy independence. With the support of the international community, notably the EU, the International Monetary Fund and the OECD, Ukraine has adopted a broad range of reforms aimed at establishing a well-functioning public governance and judiciary system and reinforcing public trust.

These efforts notwithstanding, corruption continues to plague Ukraine’s energy sector and affects its attractiveness for foreign and domestic investment. Misappropriation of public funds for energy projects, corruption, and – as described earlier in this Review – a weak judiciary have all affected Ukraine’s energy sector attractiveness. Corruption in Ukraine happens through different channels such as procurement, privatisation of state assets, infrastructure development, and management of SOEs, to name a few. Unless Ukraine addresses these challenges, it will continue to face issues with respect to its attractiveness for foreign and domestic investors in its energy sector (OECD, 2019[2]).

Reforms positively affecting Ukraine’s energy sector public governance have advanced

The 2014 Euromaidan events created an impulse for the government to reform the energy sector and strengthen the fight against corruption. Since then, Ukraine has continued to reform the country’s energy sector to promote security and sustainability while attracting investors, as is discussed in previous chapters of this Review. For instance, as highlighted in chapter 2 of this Review, in 2015, Ukraine adopted the Natural Gas Market Law1, which is aligned with the unbundling requirements of the EU Directive 2009/73/EC and established an independent system operator model. Notably, the law reformed the SOE Naftogaz and liberalised gas prices, which until 2015 were regulated and heavily subsidised, resulting in major financial losses for Naftogaz (Chatham House, 2018[3]). As is also discussed earlier in this Review, in 2016, with the support of the international community, Ukraine developed a modern regulatory framework and established an independent energy regulator – the National Energy and Utilities Regulatory Commission (NEURC). In October 2018, Ukraine raised natural gas tariffs for regulated markets and started reforming some of its state-owned enterprises. The year before, Ukraine adopted the Electricity Market Law2, which called for the establishment of an independent and certified transmission system operator (TSO) integrated into the ENTSO-E. In 2018, the Ukrainian government introduced an open auctions practice for granting licences for natural resource extraction which increased transparency of actors in oil and gas production.

Another important step forward for Ukraine, as is discussed in chapter 2 of this Review, has been the establishment of the ProZorro platform for public procurement procedures that has enhanced transparency of public procurement procedures and reduced risks for corruption, including in the framework of energy sector infrastructure investment projects.3 The reliability and good reputation of ProZorro made it an easy choice to be part of the Open Contracting Partnership with the World Bank and the World Trade Organisation (Open Government Partnership, 2019[4]).

In March 2018, Ukraine adopted the Law On Privatisation of State-Owned and Municipal Property4 which changed the process of large-scale privatisation5, replaced numerous and often contradictory regulations, reduced the privatisation timeline, and made the online ProZorro6 electronic system mandatory for the privatisation of small SOEs. In addition, the Law On Privatisation of State-Owned and Municipal Property gave additional guarantees to investors by introducing the option of referring disputes to international commercial arbitration (Article 26, para. 12, Law On Privatisation of State-Owned and Municipal Property) as well as the obligation to employ international advisers for the sale of larger SOEs.

More generally, since the 2014 Revolution of Dignity, Ukraine has undertaken several legislative reforms to strengthen its anti-corruption legal and institutional framework. The establishment of the National Anti-corruption Bureau of Ukraine (NABU) in 2015 and the High Anti-Corruption Court (HACC) in 2019 have been one of the most important recent achievements (Gerasimov and Solonenko, 2020[5]). In 2014, Ukraine introduced the obligation for public officials to submit electronic asset declarations with all property and interests an official may have.

To further fight high-level corruption and improve its financial asset declaration legislation, in June 2021 Ukraine adopted amendments to the Code of Ukraine on Administrative Offences and its Criminal Code, introducing criminal liability for declaring inaccurate information and for failing to submit a financial asset declaration. Strengthening Ukraine’s financial asset declaration legislation was very much needed, given that 99% of asset declarations audited in 2017-2019 contained false information.7

Measures have also been taken to improve public governance and reduce corruption risks at sub-national level (OECD, 2018[6]), notably by creating new opportunities for citizens to hold local authorities accountable for managing local public resources (Chatham House, 2018[3]). In January 2020, a new law8, which establishes additional protections and provides financial incentives for whistle-blowers who report alleged cases of corruption or corruption-related offenses, also entered into force. In addition, the introduction of new rules for tax administration and judicial system reforms, as well as the establishment of a Business Ombudsman Council in 2015, have improved Ukraine’s overall investment climate with regards to the fight against corruption and misconduct in the public sector.

These developments illustrate the willingness of the Ukrainian government to acknowledge the problem of widespread corruption and to implement practical measures to address it. As a result of these measures, Ukraine gained three points in the Transparency International’s Corruption Perceptions Index 2020 (CPI) compared with 2019, ranking 117^th in the 2020 Corruption Perceptions Index out of 180 countries. Despite Ukraine’s efforts to combat corruption, however, the country still suffers from negative perceptions of corruption remaining widespread. This perception is reflected when Ukraine is compared with other economies. For instance, in the 2020 edition of the World Justice Project Rule of Law Index, Ukraine ranked 72^th out of 128 in the rule of law category, performing below countries such as Belarus (68^th) and Kazakhstan (62^nd). The World Justice Project Rule of Law Index also measures countries' performance with regards to the absence of corruption by considering different forms of corruption, notably bribery, the improper influence of public or private interests, and the misappropriation of public funds or other resources. In this category, the Government of Ukraine ranked 110^th out of 128 countries worldwide and 7^th out of 14 in Eastern Europe and Central Asia in 2020.

Ukraine has established an institutional and legal anti-corruption framework but anti-corruption agencies’ work and law enforcement remain a challenge

The institutional setting of the law enforcement system has been a focus of reform as well. For the past seven years, Ukraine has implemented important reforms to establish a more effective anti-corruption institutional architecture, including establishing the National Agency on Corruption Prevention, the National Anti-corruption Bureau of Ukraine, and the Specialised Anti-corruption Prosecutor’s Office, and the Asset Recovery and Management Agency (Box 7.1). These specialised agencies were empowered to detect and investigate high-profile corruption, including cases involving sitting-in-office high-level officials. Since October 2016, Ukrainians have been able to examine public officials’ asset declarations. In 2019, Ukraine established the High Anti-Corruption Court (HACC) as a way to address the ineffectiveness of Ukraine’s regular courts in dealing with high-level corruption. The first year of activity of the HACC resulted in 16 verdicts in high-level corruption cases, in some cases leading to long prison sentences (European Commission, 2020[7]). Along with these institutions, in 2018, Ukraine established the State Bureau of Investigation (SBI) to investigate crimes committed by high-ranking officials. In addition, the National Agency for the Prevention of Corruption (NAPC) became operational in 2016 to develop and implement anti-corruption policies with the overall objective of making corruption prevention stronger. However, the framework in which these bodies operate remains weak, and the enforcement of many anti-corruption safeguards meets resistance and stalling, thereby putting the success of other anti-corruption efforts at risk. In October 2020, the Constitutional Court of Ukraine (CCU) found the practice of holding officials criminally liable for false asset declarations to be unconstitutional and stripped the NACP of many of its key functions, including its powers to control and verify declarations.9 The CCU also called into question the constitutionality of a NABU senior management appointment. Major donors, including the G7 countries and the IMF, have called on the government to counter efforts to roll back anti-corruption reforms. The IMF also notably withheld from Ukraine a scheduled tranche of USD 700 million due to the Court’s actions.10

While the jurisdiction of NABU and SAPO are set out in law, in practice some cases falling under their jurisdiction have been investigated by other agencies, which has led to their mandate being undermined. For instance, in April 2018 the court acquitted the Security Service of Ukraine officer who had been charged with an abuse of influence, because the case had fallen under the jurisdiction of NABU but had been investigated by the Military Prosecution Office. Attacks on anti-corruption agencies, and especially NABU, have continued throughout their existence. Another major obstacle to NABU’s work is that the agency is not habilitated to do independent wiretapping, which often leads to information leaks about NABU investigations to the Security Service (OECD, 2019[10]).

Risks of corruption and policy capture of Ukraine’s energy sector remain an issue from investors’ perspective

As discussed in Chapter 5 of this Review, the importance of Ukraine’s energy sector, as well as the complexity regarding the management of large energy infrastructure projects involving different state bodies, create additional risks of corruption. As confirmed by previous OECD studies, corruption continues to challenge actors in Ukraine’s energy sector. This is especially true in the oil, gas, and energy sector, where corruption appears to be most widespread in Ukraine (OECD, 2018[11]). Corruption has been detected in many of the leading SOEs of the energy sector, such as Naftogaz, Energoatom, Ukrnafta, Ukrgazvydobuvannya, and Centerenergo (OECD, 2018[11]). To this day, oligarchs continue to dominate key sectors for Ukraine, such as energy, and exert an influence on the state through their representation in Parliament (World Bank, 2020[12]).

This finding is also aligned with the investigations of cases of corruption of Ukraine’s anti-corruption bodies – the NABU and the SAPO. Since its establishment in 2015, in co-operation with SAPO, NABU has launched 986 pre-trial investigations in high-level corruption cases. In addition, NABU has submitted a total of 265 cases to courts, resulting in 41 convictions, as the vast majority of cases were blocked in Ukraine’s ordinary courts (European Commission, 2020[7]). An important part of NABU’s investigation and findings of corruption abuses concern Ukraine’s energy sector, which according to NABU remains the most corrupt in Ukraine’s economy.11 NABU’s investigations of Ukraine’s energy sector have revealed corruption schemes such as bid-rigging, the purchase of goods and services by state-owned enterprises at inflated prices, bribery and tender purchases at unsolicited or superfluous prices (Box 7.2). In terms of the volume of corruption abuses, Ukraine’s fuel and energy complex occupies the first place, causing financial losses of more than UAH 3 billion (NABU, 2020[15]).

Judicial reform has advanced but important challenges need to be addressed

As discussed in previous chapters of this Review, Ukraine has undertaken significant reforms over the past five years to improve its judiciary. In 2016, Ukraine’s judicial reform advanced with the creation of a new Supreme Court and the reduction of the number and levels of courts from four to three. Following constitutional amendments in 2016, the authority to appoint judges was transferred from the Ukrainian Parliament to the High Council of Justice (HCJ). Other more recent reforms took place in 2019, notably strengthening the independence of the National Agency on Corruption Prevention (NACP)12 and reforming the Public Prosecutor’s Office of Ukraine.13

Despite these encouraging developments, the public perception of judicial independence has improved only marginally. In 2021, almost 80% of Ukrainians did not trust courts and judges, according to a survey conducted by the think-tank Razumkov Centre in March 2021. According to a survey on Ukraine’s investment climate released in September 2021 by the American Chamber of Ukraine, 93% of surveyed businesses stated that implementation of real and effective judicial reform, the rule of law, fair justice, and the eradication of corruption constitute the government’s primary objectives in order to deliver economic growth, improve the business climate, and attract FDI (American Chamber of commerce of Ukraine, 2021[16]). The integrity and independence of Ukraine’s judiciary are still seen by domestic and international investors as hampering Ukraine’s ability to fight corruption. An important issue remains the independence and the integrity of the High Judicial Council of Justice, which is a collective, independent judicial self-government entity responsible for the appointment or dismissal of judges. Further evidence suggests that the HCJ exercises pressure over independent judges through disciplinary investigations and has taken part in corruption schemes involving judges and public officials (Box 7.3). In April 2021, the President of Ukraine initiated the liquidation of the Kyiv District Administrative Court (KDAC), frequently referred to as the epitome of alleged judicial corruption in Ukraine.14

To further address the aforementioned issues, in July 2021 Ukraine adopted the Law “On amendments to certain legislative acts of Ukraine concerning the procedure for selection (appointment) to the positions of members of the High Council of Justice and the activities of disciplinary inspectors of the High Council of Justice" (No. 1635-IX, in force as of August 5, 2021). It provides for the establishment of an Ethics Council with a mandate of six years to assist the bodies selecting the members of the High Council of Justice (HCJ) in determining whether the applicants for the position of member of the HCJ and the current members of the HCJ meet the criteria of professional ethics and integrity. The new law envisages that the first composition of the Ethics Council will comprise three active or retired judges appointed by the Council of Judges and three appointed by international organisations with experience of working with Ukraine on anti-corruption and judicial reform issues. For the approval of any decision of the first Ethics Council, the decision must be supported by at least two international experts.

Of particular importance for Ukraine’s judiciary has been the issue of there being a shortage of judges. As of June 2021, there were approximately 1977 vacancies for judicial posts, a shortage that has resulted in an increase of the length of time that is required to resolve cases. The main reason for this shortage is that at the end of 2019 with the adoption of law No. 193-IX, the High Qualification Commission of Judges, which is responsible for the selection of judges, ceased functioning. In response to this problem, in July 2021, Ukraine adopted two laws aimed at rebooting the High Qualification Commission of Judges (HQCJ) (Law No 1629-IX) and reforming the High Council of Justice (HCJ) (Law No 1635-IX), which entered in force on 5 August 2021.

In addition, according to Article 95, para. 5 of the Law “On the judiciary and the status of judges” (Law № 1402-VIII), a Competition Commission will be established to select candidates for the position of a member of the High Qualification Commission of Judges of Ukraine who meet the criteria of integrity and professional competence. More recently, on September 17, 2021, the Acting Chairman of the HCJ signed an order appointing the first members of the Competition Commission, which will elect the members of the HQCJ.

Ukraine’s flawed judicial system is widely regarded as a major obstacle for both domestic and foreign business, and distrust of the judiciary is one of the reasons why foreign investors may be deterred to invest in Ukraine’s Energy sector. Ukraine needs to continue working on judicial reform, ensuring consistency between different laws and strengthening the integrity and independence of its judiciary.

Public procurement in the energy sector continues to be perceived as vulnerable to corruption and collusion

For the past five years, significant progress has been made in modernising and increasing transparency of public procurement in Ukraine. For example, in 2016, the Law on Public Procurement15 was aligned with the 2014 EU-Ukraine Association Agreement.16  More recently, the latest amendments to the law “On Public Procurement” that entered into force in April 2020 introduced more social and environmental aspects related to RBC practices.

Notwithstanding this new environment, the proportion of businesses that regard corruption in public procurement as very or fairly widespread in Ukraine’s public opinion is high. Anecdotal evidence abounds that powerful private operators exert pressure on public administration to channel public procurement to major companies linked through circles of influence to them. Investors report that bribes and diversion of public funds due to corruption and favouritism in decisions of government are still challenging their businesses in Ukraine’s energy sector. A forthcoming OECD Typology of Corruption Schemes in the Energy Sector in Ukraine will document cases of corruption in the energy sector and will show that an important share of them involve corruption schemes in the public procurement process (Box 7.4).

Echoing these concerns, the legislation governing public procurement has been amended on several occasions, with each amendment enhancing transparency and control. Bid rigging is an administrative offence in Ukraine and has long been an enforcement priority for the Ukrainian Competition Authority (AMCU). In a 2021 assessment of procurement practices of Ukrenergo against the OECD Recommendation on Fighting Bid Rigging in Public Procurement (OECD, 2012[19]), the OECD found that procurement at Ukrenergo is already highly professional although more could be done to target the problem of bidder collusion in tender design and preparation and to detect bidder collusion. The report proposed several ways of achieving this objective (OECD, 2021[20]). The Recommendation on Fighting Bid Rigging in Public Procurement (OECD, 2012[19]) as well as the OECD 2015 Recommendation on Public Procurement (OECD, 2015[21]), which is the overarching OECD guiding principle that promotes the strategic and holistic use of public procurement, could be used by other SOEs in Ukraine as well as public procurement agencies to benchmark their own practices and adjust them accordingly.

Outlook and policy recommendations

The impact of the COVID-19 outbreak on Ukraine’s economy, including on the energy sector, the ongoing conflict in eastern Ukraine, and the high perception of corruption and of a weak justice system in the country have been challenging for investors interested in Ukraine’s energy sector. Despite significant governance and judicial system reforms, as well as in the area of public procurement, trust in the government’s combat against corruption remains low.

• Continue ongoing reforms to prevent and combat corruption, with a special focus on high-level corruption.

• Ensure the independence of the anti-corruption agencies, NABU, SAPO, and the High Anti-Corruption Court, and that these agencies are sufficiently resourced, staffed, and empowered to conduct investigations, as well as shielded from political and other improper interferences.

• Pursue a holistic approach for reforming Ukraine’s judiciary in line with international standards and good practices. Continue judicial reforms to strengthen Ukraine’s judicial independence and effectiveness and increase public confidence; address inconsistencies in legal and regulatory frameworks.

• Continue actions to simplify and make more transparent public procurement proceedings in line with the findings of the forthcoming OECD Typology of Corruption Schemes in the Energy Sector in Ukraine, including ensuring clear and accessible policies on procurement in SOEs and encouraging the establishment of specialised board committees on procurement when appropriate. Given that the public procurement system in Ukraine still suffers from low trust by businesses and citizens alike, the country could make further use of the OECD Recommendation on Fighting Bid Rigging in Public Procurement and of the OECD Recommendation on Public Procurement. Ukraine should also continue to seek international assistance, which can provide capacity-building training that is focused on the fight against corruption and conflicts of interest in the procurement system.