Cover Story (#5-6 May-June 2020)

Highest Standards

The concept of corporate governance is widespread around the globe, helping companies to reach greater levels of efficiency and sustainability. It is an evolutionary process for that business whose strategic aim is to explore new markets and investment opportunities.

The tradition of corporate governance in Ukraine is on its way to being established, while legal advisors play a crucial role in this process. We asked two partners of Kinstellar, Olena Kuchynska, a leading expert in corporate governance and head of the local energy practice, and Iryna Nikolayevska, head of the corporate/M&A to tell us how it operates in current Ukrainian realities and how corporate governance is able to contribute with the application of the worlds highest standards.

UJBL: What is corporate governance, and how does it work?

Olena Kuchynska: Corporate governance has a number of dimensions for corporate lawyers in Ukraine. First of all, corporate governance is our profession. It is also a set of extensive legal regulations, which in Ukrainian realities change quite regularly. It is the best practices that many claim to follow, though often implement the way they like, and which apparently do not exist, as there cannot be only one scenario thats suitable for all. Finally, corporate governance is an idol that some people pretend to worship but, in fact, in many instances, are afraid to animate.

Corporate governance is, in effect, a comprehensive system of rules, organizational culture, values, and practices, including relations among stakeholders (persons whose interests and well-being can be affected by the company) that define how a company is directed and which, ultimately, contributes significantly to the creation of company value.

An operational and fully-empowered Supervisory Board is a key though not the only element of the corporate governance system. It is in charge of making the corporate governance system work.

UJBL: Is corporate governance essential for both public and private companies? How does it influence business development? Do you see any shortcomings?

O.K.: Establishing proper corporate governance is equally important for both public and private companies, companies with state ownership and family-run companies, though it may mean a different thing for each. In the current complex and rapidly-changing environment, for a company that would like to develop, attract investment and/or explore new markets, it is very risky, and actually no longer acceptable to be run by one person.

Effective governance is essential for various stakeholders. Investors want to be certain that their investment target has a system in place to prevent the misuse of funds and to increase the value of their investment. Shareholders may have different interests and they may conflict with the interests of the company. For instance, when the government is the shareholder and the company sells commodities to its voters at a regulated price. Employees expect competitive remuneration and incentives to constantly increase; they should also value high health and safety standards. Customers are interested in uninterrupted supplies; contractors, competitors, regulators, policymakers each has their own interests towards the company that somehow need to be managed and taken into account. Quite a task, right? Corporate governance deals with this.

Iryna Nikolayevska: Many sceptics could argue that establishing corporate governance is an expensive exercise. The first and most obvious thing is that you have to pay fees to the Supervisory Board members, hire a number of other highly-qualified employees such as internal auditors, and staff compliance and risk management functions. Moreover, taking management decisions according to procedures requires much more time and effort than a one-man show. However, experience shows that if you get corporate governance right it will pay dividends, maybe not in the short term, but definitely in the longer run. There are already vivid examples of this in Ukraine.

UJBL: Where should a company start to implement good governance?

O.K.: Each company has at a particular point in time a certain level of corporate governance. There are legislative rules and internal documents, such as the company charter, policies and procedures, which set a framework for the company and its decision-making, its system of internal controls, interaction among shareholders, the Supervisory Board and management, and so on. However, we note from our experience that it is not uncommon for the rules and practices of corporate governance to differ significantly. For various reasons lack of qualified staff, undeveloped culture or lack of values even very advanced rules may in practice be ineffective and a burden for the company and not a benefit for it.

As a first step, it is very important to review the rules, investigate how they are actually implemented and identify any gaps for the particular company. It is also important to understand your needs and expectations and to develop a tailored model that takes into account the development stage of the company, its strategy, legislative requirements and recommendations. The final, and crucial part, is to set up your model. A detailed, comprehensive plan will most likely be required in order to outline the steps, define the timeline, and make an assessment of the necessary resources.

UJBL: Are there any distinctive features of corporate governance in Ukraine?

I.N.: Ukrainian corporate governance is only just emerging as a system, so there is a need to find solutions to make it work for the benefit of all stakeholders. Ukrainian corporate governance laws and regulations are not perfect but they are quite detailed and rigid. Lawyers compete to find gaps in them, businesses complain about overregulation, and legislators continue to set new rules. However, the overall practice of corporate governance remains at a rather low level in Ukraine. There may be various reasons for this.

Firstly, the tradition and culture of corporate governance in Ukraine only being established now. Our economy began its transformation towards a free market system less than 30 years ago, though the state sector continues to constitute a significant part. Secondly, the Ukrainian stock market has been underdeveloped, so its instruments and incentives are not generally available for businesses. This has led to the situation where the majority of large and medium-sized businesses are either privately owned or state-owned. Private owners and the state tend, to a large extent, to treat corporate governance more as a risk to their autonomy and ownership rights rather than a benefit. However, we believe that positive examples and wider awareness will gradually alter this attitude.

UJBL: What is the role of a legal consultant in establishing corporate governance and its further development?

O.K.: As legal consultants we have been working in Ukraine on corporate governance projects with private and public companies, including with the state sector. Taking into consideration the situation with our law-enforcement and judicial systems, legal formalities are very important in Ukraine.

However, in the case of corporate governance, compliance with legal formalities which in many cases are unclear and controversial is of a low standard. Culture and values play an extremely important role, too. So, a good corporate governance lawyer needs to possess skills and experience to navigate a client through legal formalities while having the right values and key principles and an understanding of current trends and common approaches. For instance, we had a case with a conflict of interest of a member of a supervisory board which, due to gaps in legislation, could have been managed to the detriment of the company. Fortunately, the high ethical standards of the supervisory board played a key role in that particular case and actual conflict was avoided.

In our current reality lawyers have to know more than just regulations: they have to be trusted advisors and have deep knowledge of how the corporate governance system is established, how it operates and when it requires change, in order to effectively support clients. First-hand experience is crucial here.

UJBL: As we observe the Ukrainian legal market on a consistent basis, we have noted the first-hand experience of your team in corporate governance in both the private and state sector. How would you describe the difference?

O.K.: Indeed, we have been working a great deal with both state-owned and privately-owned companies. Despite a few attempts to ensure a level playing field for both, Ukrainian legislation contains many specific rules that apply only to state-owned enterprises (SOEs), the majority of which place SOEs in discriminatory conditions. For example, the supervisory boards of SOEs do not have sufficient delegated authorities, e.g., the ability to approve the strategy or financial plans; the approval of the government or specific ministries is required for borrowings and the disposal of property; the remuneration of top executives may be limited by governmental decision without discussion with the supervisory board, which is by law empowered to set such remuneration. This decreases the role of the supervisory board of SOEs to the level of an advisory body.

I.N.: Private sector companies generally have more flexibility and are subject to less political influence compared to SOEs. On the other hand, quite often due to a lack of motivation, resources, information or undeveloped corporate culture, many private Ukrainian companies do not pay necessary attention to the development of their corporate governance system. However, we are now observing that there is growing interest in the private sector on this topic (driven substantially by recent reforms in the state sector), which significantly raises the awareness of stakeholders. We therefore believe that corporate governance standards on the Ukrainian market will soon increase significantly.

UJBL: While advising on corporate go-vernance in the state sector, have you observed any influence from civil activists and attention from the media?

O. K.: The role of civil society and of journalists is very important in exercising control over the state sector. At the same time, I would say that this is more relevant to cases where no proper corporate governance or internal controls have been established in a particular SOE. In my view, for instance, it is not a good sign when procurement processes are cancelled due to corruption allegations coming from journalists and activists; this poses questions for the compliance function and raises concerns about the effectiveness of other elements of internal controls.

The other aspect of this worth mentioning is a balanced approach. We have seen cases where corporate governance practices improved as a result of the pressure of activists, though in other instances this was used with the intent to distort the operations of the Supervisory Board and the company.

UJBL: Is there a recent project you would like to highlight? Why do you regard it to be significant?

O.K.: We have been working on a number of significant corporate governance projects and it is difficult to single out a specific assignment. Our projects range from assisting with the reform of corporate governance of major SOEs to advising supervisory boards of various state and private companies and banks on a large spectrum of issues in the course of their activities and consulting individual supervisory board members, executives and Chief Compliance Officers on a wide range of topics, including conflict of interest, distribution of powers, liability and liability insurance, anti-corruption obligations of officers, etc.

Corporate governance projects are exciting as they give us a chance not only to get to know more about the company and its industry, operations and goalsthey also give us a unique chance to take part in improving the applicable regulatory framework, which extends not only to standard corporate matters but also covers specific industry or sector regulations. In many cases such projects are driven by management looking to establish proper corporate governance so as to make use of all of its benefits, the first of which is the establishment of an effective supervisory board that can be a truly professional, independent and valuable partner. In such projects we work as one team with the company, other consultants and various stakeholders. We share our experience and knowledge and have intensive discussions to develop a system that can bring value. It is also very motivating to see how the corporate governance of a company changes over time and how its operations improve, and you realize that you have contributed to this transformation.

I.N.: Advisory projects are very challenging: they require profound legal expertise and understanding the companys business and context and background for its specific decisions. As we work with very diverse and professional supervisory boards, this brings fantastic experience and on-the-ground knowledge to our team.

UJBL: Do you anticipate further scaled reform of corporate governance in our country?

O.K.: Definitely. Having completed a number of corporate governance reform projects in the state sector, we have identified a number of areas where changes are required. Frankly, we have been waiting for these changes now for almost five years. Moreover, there is a draft law submitted to Parliament that would introduce one-tier boards into the Ukrainian legal system. A one-tier board is a body consisting of both executive and non-executive directors. This arrangement is more common to the Anglo-Saxon legal system and it is debatable how it will work in Ukraine.

Another very interesting legislative initiative is the introduction of gender quotas to supervisory boards. Admittedly, gender diversity is yet to be seen in boardrooms in Ukraine, and given that rotation in supervisory boards happens infrequently, without legislative support it may take quite a long time. Much research with different conclusions has been done to determine whether such diversity has a positive impact on a company. At the same time, we are not aware of any research saying that the impact would be negative. In our view it is hard to disagree that the dramatic gender discrepancy in Ukrainian boardrooms, which under-represents the majority of the population that is equally well educated and experienced, has to be addressed either by legislators or by investors. This would be in line with current trends in the corporate world, where major international institutional investors do not support boards without diversity.

Overall, we expect the market to become more mature and public awareness to rise, as corporate governance standards both for public and private companies will increase further in Ukraine.


KEY FACTS

Kinstellar

Year of establishment: 2006

Location: Kyiv, Ukraine

Number of partners/lawyers: 3/15

Core practice areas:

  • Banking, Finance & Capital Markets
  • Competition & Antitrust
  • Compliance, Risk & Sensitive Investigations
  • Dispute Resolution
  • Employment & Labour Law
  • Energy & Natural Resources
  • Infrastructure & Projects
  • IT & Telecommunications
  • M&A / Corporate
  • Real Estate & Construction
  • Restructuring & Insolvency

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