Cover Story (#1-2 January-February 2021)

Investment Technology

Ukraine has at its disposal unique geographical location at the crossroads of the main trading routes between Europe and Asia. But this strong advantage and great ambitions to become the core transit hub face the big problem of an obsolete transport infrastructure inherited from Soviet days, which requires significant investment. How should the interests of private investors and the state be secured, at the same time preserving a reasonable balance? We discussed the development of existing investment technologies with Andrii Pidhainyi and Marina Sharapa, partners of AGRECA Law Firm, who have been involved in shaping sectoral policies for the last decade.

What are the key trends in global infrastructure today? How has COVID-19 affected the sectors development around the world?

Andrii Pidhainyi: When we are talking about the impacts of COVID-19 in the transport sector, first of all, we mean a dramatic decline in demand. Lockdown measures caused a sudden reduction in the usage of public transport and road infrastructure. Against this background, owners and operators of transport infrastructure, as well as investors, try to understand how long this chaos will last and how to map out their strategies and activities for coming years. At the same time, they try focusing on existing challenges, such as the reduction in capacity, rising costs and disruption of supply chains. That is how the overall picture looks.

In this context, it would be noteworthy to look at the current state of infrastructure development in Ukraine. As weird as it may sound, I would assess the changes for the better.

What are your observations on recent investment opportunities in the Ukrainian infrastructure sector? What are the prospects of state assets-related transactions? Which forms of cooperation are more attractive for private investment, and why?

A.P.: We have definitely witnessed a stepping up of investment activities in the transport infrastructure over the last 5 years. The first steps were taken in the seaport sector, where two concession transactions in Olvia and Kherson ports were completed successfully in 2020. The Minister of Infrastructure has also announced the upcoming concessions in the ports of Odesa, Chornomorsk, Berdyansk, Mariupol, and Reni. In addition, three state-owned stevedoring companies are in the process of preparation for privatization. These assets are already expected to go on sale in the middle of this year.

We must admit that the authorities have the same great ambitions in other transport sectors. For example, pre-feasibility studies for private sector participation have already been finished in the road, railway, and air transport spheres. It means we can expect real PPP projects in coming years.

Marina Sharapa: Regarding forms of cooperation. It is becoming obvious that Ukraine has changed the approaches to investment options from the lease, as was widespread in the port sector, to PPP in the form of concession. This was made possible through significant improvement of the PPP legal framework as well as the permanent involvement of international financial institutions.

Indeed, international financial institutions and other donors are consistently involved in projects aimed at reviewing sectoral regulation, and your firm regularly acts as a legal counsel. How often, in time and scope, are these high-profile recommendations implemented into state policies?

M.S.: Indeed, such organizations provide technical assistance not only in the implementation of investment projects or whole sector-specific programs, but they also finance the development of laws and recommendations for promoting reforms. In particular, the development of the brand-new Concession Law has been financed by the EBRD. In its turn, the World Bank Group provided the development of the Strengthening Ukraines Port Sector Governance Report, which consists of analysis of current structural issues in the port sector and recommendations in the way they are addressed. As a result, we have obtained the improved Port Development Strategy in Ukraine to 2038, which includes such key provisions from the report as the introduction of the landlord model in Ukrainian ports. However, its worth mentioning that implementation of the Strategy leaves a great deal to be desired.

The Ukrainian government has announced its new privatization program. Do you see growing interest in infrastructural assets?

M.S.: Currently, assets related to the transport infrastructure are few and far between on privatization lists. This is due to several factors. The most significant assets, so-called strategic property, such as public railways and roads, aerodromes as well as port infrastructure, are not subject to alienation by law. According to national policy, for remaining infrastructure assets, the state gives preference to the private-public partnership. As a result, we have only three stevedoring companies selected for privatization purposes. I am talking about the three most unattractive stevedoring companies in the most retrogressive ports of Ukraine: Skadovsk, Belgorod-Dnistrovsk and Ust-Dunaisk. There wont be a queue of investors, but I am confident these assets will find their private owners.

Ukraine has one of the most developed railway networks in Europe, as inherited from the Soviet Union. Hence, it requires deregulation to enable private investment in strategic infrastructure. As we know your expert involvement in the upcoming reform, how would you comment, in brief, on its prospects?

M.S.: Ukraine has also inherited outdated sectoral-related legislation. The only hope is the adoption of the all-new and progressive Law on Railway Transport, the draft of which is the subject of permanent talks between the government and the business community. Your question on enabling private investment in strategic infrastructure is one of the sticking points. The last version of the draft law developed by the authorities doesnt provide such an opportunity. This is a real challenge for players of related markets, whose activities depend on public infrastructure development. Taking into consideration the limited financial ability of state rail operator Ukrzaliznytsia we can expect, for example, a decrease in the throughput capacity of port-related rail stations or even main railway lines. The other key challenges are the unbundling of Ukrzaliznytsia, the establishment and further functioning of a national transport regulator, changing tariff policy as well as opening up the freight market.

In the past year the idea of passing Ukrainian railways into the management by Deutsche Bahn was widely mentioned in the media. Is this, in your opinion, reasonable?

M.S.: The Memorandum of Understanding was signed at the beginning of 2020. According to Deutsche Bahn this is not about the transfer of management but a strategic partnership where the German side will provide support in the analysis and reorganization of various business areas and operations and management optimization. The Memorandum is not public, and we can only evaluate these relations on the basis of official statements.

Of course, as legal consultants in the transport infrastructure, we welcome and appreciate possible strategi collaboration and the opportunity to gain experience and professional advice. The fact is that in April 2020 the Minister of Infrastructure, Mr. Kryklii, announced the postponement of cooperation.

Are ports the most lucrative areas for concession projects? What are the landmark events in the sector?

A.P.: Theoretically, they are. Marine terminals operate in free markets and port concessions are considered as commercial projects where the concessionaire earns profit at its own risk directly from customers. A concessionaires revenue depends on market conditions and the state of the economy overall. By comparison, road concessions work in the monopolistic market with a significant social component. If a concessionaires profit does not cover its investment, the grantor has to reimburse the difference in the form of the availability payment.

First of all, I would highlight the adoption of amendments to the Port Development Strategy in Ukraine. The changes envisage the next step of port evolution through implementation of the landlord port model. It will take a long time, but we have to launch this process as soon as possible. As I mentioned before, the port sector is the pioneer of Ukrainian concessions. The first experience has been gained within the successful implementation of two concession projects in the ports of Olvia and Kherson. About six projects are on their way. The main achievement, despite the global slump, is that the Olvia and Kherson contracts have been signed. At the same time, I would emphasize the other, no less important acquisition: the legal framework, knowledge, experience, skills, and overall development of the PPP area in Ukraine. I call it investment technology, without which it is impossible to attract external investment.

What are the achievements and gaps in the reform of seaports?

A.P.: Port reform started in 2013. Thanks to the Law on Seaports adopted one year earlier, 18 state-owned port enterprises were reorganized by allocating strategic assets to a newly-formed state-owned entity called the Ukrainian Sea Ports Authority, or USPA. This ensured the separation of administrative functions which had been transferred to the USPA and commercial operations which had remained with state-owned enterprises. These enterprises currently operate as stevedoring companies. Global changes also include the liberalization of tariffs for transshipment services and a new approach to the definition of seaport. Now it is not a legal entity, but the territory equipped for port operations.

The updated structure of port relations has brought about new challenges which neither the government nor business had been ready for. If, according to the new rules, the port territory may consist of state, municipal or private land plots, and they are operated by entities of various forms of ownership, then there is an objective need for unified management and planning of the port territory, permanent collaboration with investors and local municipalities. Therefore, the promotion of the landlord model is so important in our ports. The landlord port model means that the port authority is responsible for the development of the port territory, possessing a broad range of powers in attracting investment, disposing of property, including land plots and so on. Such powers are currently distributed between ministries and other central and regional authorities.

Many expert assessments outline that the capacities of inland waterway transport have underestimated potential compared to that in neighboring countries. What new developments can you see after the recent adoption of the law?

M.S.: I agree. If you look at the map of Ukraine, you will see the waterway stretching from the north to the south across the entire country, dividing it into two parts. Indeed, the River Dnipro has a unique location with great opportunities for passenger as well as freight transportation. And we shouldnt forget the other navigable rivers of Ukraine: the Danube and the Pivdennyi Buh, which also have access to the Black Sea. According to the Ministry of Infrastructure, only one percent of freight transportation in Ukraine is moved via rivers. It looks strange because river transportation is the most economical and environmentally-friendly method of cargo delivery. The government expects the development of a competitive market in this sphere and counts on growth in goods traffic of up to 30 million tonnes per annum.

However, we have to understand that the adoption of the Law on Inland Waterway Transport is only the first step. In order to apply the Law in full, a set of laws and regulations needs to be adopted. The most significant one is the Law on Establishment of the State Fund for the Development of Inland Waterways, the draft of which has already been registered in the Verkhovna Rada. The aim of the act is to address the key issue: funding the reconstruction, repair and maintenance of hydro-technical facilities. Simultaneously, the existence of an alternative draft makes the future of the law unclear. I have to admit that not all market players are satisfied with the Law on Inland Waterway Transport and we might witness permanent disputes within the expert community and debates inside the walls of Parliament.

What are the main concerns regarding private sector participation in road development? Is effective legislation ready for the six pilot projects planned for 2021?

M.S.: I think theres no need to describe the importance of the investment climate and other beaten arguments. We have studied previous unsuccessful attempts at road concession in Ukraine. Our findings show two key issues. The first one is the low quality of tender preparation. The tender provisions must be well-balanced. Prospective investors have to be confident that a certain project is profitable, and that the contract enables protection of their investment. The second one is legislation or, to be accurate, rules which enable the authorities to develop well-balanced tender provisions. Our aim must be to attain a faultless legal framework, and to keep improving it on a permanent basis.

Despite the previously failed tenders for road concession, I believe this investment instrument has a future here in Ukraine. Thanks to the World Bank Groups support as well as the involvement of the Ministry of Infrastructure project offices RST and SPILNO, the preparation of the pilots focuses on every detail and performance quality. For example, part of the study has been dedicated to improving legislation related to the implementation of PPP projects. As a result, the government recently approved the vital draft law on amendments to the Budget Code that seeks to apply the availability payment mechanism. The availability payment is a payment from a public partner for the benefit of a private partner which depends on reached performance indicators provided by a contract. The payment is made in the event that the private investment cant be reimbursed directly from customers. The Ukrainian road PPP or concession projects refer to such cases.

Work on other amendments, in particular, to PPP laws and by-laws is continuing.

With the dramatic impact of the pandemic on aviation, what is the fate of planned concession projects at Ukrainian airports?

A.P.: The situation in this sector looks different. As we may assume, the decisions on airport concessions study were taken in 2019. There was still air traffic growth at the time. Even back then the results of financial modeling related to regional airports were not always promising. Therefore, the authorities were considering various scenarios of potential concession projects.
In particular, bundling profitable and unprofitable airports into the lot of one tender, which in turn would balance the economics of the entire project. And your question absolutely makes sense. The catastrophic reduction in demand, as well as the destructive lockdown effect, considerably aggravate the economic status of regional airports. And it makes no difference, who such airports belong to: the state, municipalities or private owners. Therefore, we havent seen the next steps for implementation of airport concessions. So, what is the way out of the current situation? And the answer is to find funding support.

Recent news has shown that the government has chosen the right way. As was revealed, the Ministry of Infrastructure initiated the establishment of a special fund for the development of airports, as it would for railways. In its turn, the EBRD has already allocated funding and selected consultants to study international experience, develop a concept, and draft relevant legislation.

In December 2020 the European Business Association presented an expert study of the general state of the development of transport infrastructure in Ukraine an Infrastructure Index, where AGRECA was one of the partners. How would you sum up its findings?

M.S.: It was a great opportunity to be involved in this expert study, which is built on a professional assessment provided by market players. This is the first ever initiative in Ukraine for the assessment of the general condition of transport infrastructure development. Lets have a look what the results are.

The integrated value of the Infrastructure Index for the past year reached 2.58 points out of a possible 5. They look like mediocre results! The respondents also highlighted the three most significant challenges facing the infrastructure market: the lack of transparency in the decision-making process on infrastructure projects, lack of an independent transport regulator as well as shortage of qualified staff in government bodies.

The level of implementation of transport development strategies received the worst assessment of other components. 53% of respondents believe that it is low, another 40% consider it to be satisfactory, and only 7% praised the implementation of transport strategies. This assessment is a kind of litmus test, which signals to society the ability of the authorities to act effectively in achieving their goals.

The Infrastructure Index 2020 has inchoated the traditional annual comparison of the authorities achievements to previous periods. We look forward to the next research index.

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