«Іmproved public procurement regulations in Ukraine can reduce corruption»

State aid and public procurement system reform is extremely important for Ukraine, particularly for the successful implementation of the Association Agreement with the European Union and other commitments in the context of European integration. We talked with the team-leader of the EU funded project, “Harmonisation of the procurement system in Ukraine with EU standards,” Eugene Stewart, about the current situation.

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The law of Ukraine, “On State Aid to Undertakings,” adopted in July 2014, stipulates a number of forms of state aid. Which of those are unusual for the European Union?

The forms of state aid are indicated in Article 4 of that law. They include grants, subsidies, capital injections on non-market terms, tax reliefs, debt write-offs, state guarantees, and soft loans. None of these are especially unusual or exotic in practice across the EU Member States. It is important also that the law does not exclude other forms of state aid. This is consistent with EU law in the sense that it is not the form of state aid that is important, but its effects on trade and competition. Thus, “state aid” must involve a cost to government, it must give a selective advantage to one or more undertakings, and it must have an actual or potential effect on both competition and trade.

Does this law meet the objectives of the Association Agreement?

The adoption of the state aid law by Ukraine is compliant with the purpose of the Association Agreement, including the Deep and Comprehensive Free Trade Area. For example, Ukraine is establishing a transparent and functioning system of monitoring and ex ante control of state aid similar to the EU system and EU-compatible legislation is required for this purpose.

The law establishes the Anti-Monopoly Committee of Ukraine as the regulator of state aid in Ukraine; it creates a mechanism for the notification and approval of new state aid measures and the monitoring of existing state aid. It establishes the basis for an inventory and register of state aid, for annual reports on state aid in Ukraine, and for the recovery of illegal state aid in appropriate cases.

At the same time, at the technical level, the law could benefit from further fine-tuning on a few points to achieve full alignment with EU state aid rules.

However, it is essentially a framework law, which leaves a substantial amount of secondary legislation to be prepared before it comes fully into force in August 2017. This secondary legislation will address both substance and procedure. Importantly, it will clarify definitions of state aid categories and establish specific rules for compatibility of state aid in each category with market competition, including the maximum permissible levels of state aid that will be authorised. The secondary legislation must, in effect, transpose some 2,000 pages of EU regulations into something understandable and operational for Ukraine. Just to take one example: the maximum amount of state aid to a new investment project needs to be set at 50% of the costs of the new investment, and the beneficiary must guarantee the maintenance of the investment for at least three years— otherwise the state aid must be re-paid.

To what extent does the current system of state aid allow certain firms to benefit and, therefore, maintain selective economic regulation?

In any country where state aid is not regulated there is generally huge scope for ad-hoc, poorly thought-out, and sometimes corrupt political decisions to give state aid to particular firms. Where particular markets are highly concentrated and where there are close links between owners in these markets and political decision makers, these risks are obviously higher. When it comes fully into force, the Law on State Aid to Undertakings will not change the past; nor, indeed, will it change the structure of markets in Ukraine. It will, however, ensure that any previous freedom to act in an arbitrary and non-transparent way (including via gross favouritism) in measures of state support to business will not continue.

There are many discussions about state-owned enterprises receiving state aid but being largely ineffective. How can this be avoided – privatisation, effective management?

Essentially there are two types of state-owned enterprises in Ukraine: the non-commercially viable and the viable or potentially-viable. Under the state aid rules that will apply from August 2017, state support to any firm in commercial difficulty will be very limited: in effect, to six months of rescue loans followed by specifically-approved restructuring aid where a viable rescue plan has been put in place during the rescue period. From the standpoint of market competition and international trade, there is no point in persistently support ailing firms (state-owned or otherwise). The application of these rather strict state aid rules will, at the same time, recognise the practicality of both the privatisation and the effective management options, together with the third option of liquidation where other options are not feasible.

There are four tests for a state support measure to constitute “state aid” in the EU: if it is provided with public resources, if it provides a benefit to the recipient, if there is selectivity, and if there is a potential danger to competition and negative impact on trade. Can these be applied in Ukraine?

These four tests are equally valid for Ukraine – if any of these do not apply, the measure is not state aid and the law does not/will not apply. The most abusive forms of state aid are direct state supports to the export of goods and services (a direct and damaging barrier to trade), operating aid to support the current expenditures of assisted firms (in most cases this is tantamount to rescue aid with no conditions related to eventual commercial viability and, thus, seriously affects competition) and production or investment aid to certain traditional economic sectors (e.g. coal and steel), which are characterised by over-capacity internationally (so-called “sensitive sectors”). In the latter case, the EU state aid rules seriously limit the provision of any state aid because it is inherently wasteful. And so-called ”export aid” is strictly prohibited under EU rules.

If one follows Ukrainian media, one would get the impression that public procurement in Ukraine is dominated by large-scale corruption, and that some people profit at the expense of the rest of society. Is this correct?

Public discussion regarding public procurement reform in Ukraine has become dominated by perceptions of corruption. The spending of public funds via public procurement obviously offers possibilities for corruption and theft – as it does in all countries. However, this is a secondary effect of a public procurement system in Ukraine that needs greater professionalism and procedural compliance, more competition, and greater transparency.

These elements reduce the scope for corruption but will never guarantee its elimination. Estimates of corruption in EU public procurement range from 25 to 50% of total contract value. Based on very limited data, the Accounting Chamber of Ukraine puts corruption at a level of 50%. Such data is difficult to measure or confirm. However, improved public procurement regulation in Ukraine can reduce the risk of corruption. More widely, however, on-going reforms in law enforcement and the judiciary in Ukraine can make an even greater contribution to ensuring that actual corruption is detected and then adequately punished.

Can the money that would be saved if the Ukrainian public procurement system were in line with the EU standards be measured?

First, the formal measurement of money saved is problematic when comparing the application of one set of rules versus others (or indeed no rules) that might have applied in the same situation. The main idea in public procurement reform is not saving money as such, but ensuring the purchase of necessary goods, services, and public works on the basis of the best value for taxpayers’ money (i.e. in the most efficient way to achieve the objective of the public contract purchase). Allowing market forces to achieve an optimal result in a public tender requires increased competition via a growth in participation in public tenders. This core approach to public procurement efficiency (together with encouraging competition and maximum transparency) is fully reflected in the EU public procurement standards and established via relevant legislation and best practices.

In regard to state aid, the situation is somewhat different. Where state aid proposals are rejected or modified by the regulator, there is a directly-calculable saving. Similarly, if illegal state aid is recovered, there is a clear saving to the public finance system of Ukraine.

Ukraine has a number of commitments regarding government procurement under the State Building Contract. Did we accomplish them?

The short answer here is essentially “yes.”

The EU-Ukraine “State Building Contract” (SBC) was signed on May 13, 2014 and is worth up to €355 million (plus an additional €10 million in support to civil society) for the purpose of assisting the government of Ukraine in addressing short-term economic stabilisation needs and implementing governance reforms in regard to the fight against corruption, public administration reform, and electoral and constitutional reform.

Under the SBC, the main public procurement conditions are: the significant reduction of the list of exemptions under the Ukrainian Public Procurement Law and the alignment of these exemptions with the categories of allowed by the EU Public Procurement Directives; a decrease in use of non-competitive procurement (negotiated procedure) to 10% of total public procurement in the first half of 2015; publication of information on procurement going through non-competitive procedures, procurement by public enterprises, annual public procurement plans and reports on the execution of contracts (on the web-sites of procuring entities), information about sub-contractors, amendments in substantial provisions of contracts, procurement contracts and information on the consideration of complaints by the review body.

In regard to exemptions, as of April 2014, there are only 15 allowable exemptions, most of which are compatible with EU standards. The previous version of the law had 39 exemptions introduced during 2011-2013 under the influence of various political and corporate interests.

The share (by value of concluded contracts) of single source (or “negotiated procedure”)-based contracts out of all contracts for the first six months of 2014 was 55.32 %. However, more than 70% of these were contracts for the procurement of gas, electricity, water and central heating, and postal services from natural monopoly suppliers, and more than 10 % related to contracts for the anti-terrorist operation in Eastern Ukraine. In the cases involving purchases from natural monopoly suppliers, the procuring entities have no alternative, under the current monopolised market conditions, but to purchase from single suppliers. Accordingly, the real share of negotiated procedure (excluding natural monopoly contracts) in the first six months of 2015 was 10%.

In regard to the enhanced publication of information, the publication requirements of the SBC are now mandatory under Article 10 of the new Law on Public Procurement (and relevant amendments to the Business Code). All of this information must be published on the official Public Procurement Web-Portal. Accordingly, the condition has been implemented in the form of a clear mandatory legal norm that is observed by all contracting authorities including state-owned enterprises and by the Anti-Monopoly Committee of Ukraine in respect of complaints.

Building on these achievements, Ukraine is now proactively finalising a Public Procurement Reform Strategy (including a road-map for the detailed adoption of EU legislation and standards in public procurement). This will set the scene for substantial additional reforms, especially over the next three years.

Background

The EU funded project, “Harmonisation of Public Procurement System in Ukraine with EU Standards” commenced work in Kiev on November 11, 2013. The project is being implemented by a consortium led by Crown Agents Ltd and will operate until November 2016. The other members of the consortium are Chartered Institute of Purchasing and Supply (CIPS) and BDO LLP.

The project activities are carried out under five project components that cover both the reform of the public procurement system and specific support for the development of the Ukrainian state aid system. Accordingly, the project is working to contribute to the development of a solid and consistent public finance management system through the establishment of a comprehensive and transparent regulatory framework for public procurement, an efficient public procurement institutional infrastructure, the accountability and integrity of public authorities in regard to public procurement, and the development of the Ukrainian state aid system.

More information about the project: http://eupublicprocurement.org.ua

The interview with Eugene Stuart for hromadske.tv: