Can corporate governance reform at Ukrainian state-owned companies attract international energy investment?

Improving corporate governance in Ukraine would send a strong signal to international investors that the country’s energy sector is an attractive prospect

Can corporate governance reform at Ukrainian state-owned companies attract international energy investment?
About the author: Olha Bosak is Director of the Center for Reforms of Oil & Gas Sector and Corporate Governance of SOEs at Naftogaz Ukraine
Olha Bosak
Friday, 26 October 2018 11:13

Investments in energy production and sustainable energy supply infrastructure are powerful drivers of economic growth and quality of life improvements. However, this does not come cheaply. Increases in oil and gas exploration and production, along with upgrades of transmission and distribution networks, require investments measured not in billions but in trillions of dollars. This means that the energy industry badly needs regular investment for its further development. All governments should encourage investment if they want their economies to become stronger.

Energy is one of the most valuable market segments in the world, but this is not enough in itself to guarantee investor interest. Investors consider many factors before choosing to stash their money in the energy business. Many investors pay attention to future growth potential, likely current returns, and other income opportunities. For ethical investors, it is also vitally important to make sure that an energy business is responsible and transparent. This is why many investors now prefer companies with strong corporate governance systems. They are interested in how companies manage themselves and maintain relationships with their stakeholders.

A recent emerging market investor survey by the International Financial Cooperation found that emerging market investors are particularly concerned about the level and quality of corporate governance. Global energy market participants repeatedly emphasize that greater transparency and easier access to energy markets can drive the entry of foreign investors. Acceptable corporate governance practices play a very important role in this process as investors consider their investment decisions.

Ukraine is currently undergoing corporate governance reform. This process is generating interest among investors, who are hoping to see an improvement in Ukraine’s corporate governance framework. What are the main concerns in the investment community and wider Ukrainian society? What can help build public trust in the Ukrainian energy business? What could encourage investors to commit? I believe the answers to these questions will lead us towards an awareness of the central importance of greater stakeholder engagement, improved governance culture, and heightened public trust.


Stakeholder Engagement

Stakeholder engagement is crucial to the success of any business. Energy companies must take into consideration the interests of their shareholders including business partners, customers, suppliers, employees, public authorities and local communities. To adhere to the principles of corporate governance means to act in response to stakeholder concerns, needs and expectations. A meaningful dialogue with present and potential stakeholders can help to establish effective business-society relations. Professional and independent boards can allow for a direct shareholder involvement.

Today one can observe a positive trend towards the establishment of supervisory boards in Ukrainian energy companies. Ukraine’s national oil and gas company Naftogaz has a supervisory board consisting of four independent members and three representatives of the state. The national power company Ukrenergo is in the process of forming its supervisory board. Questions remain over whether the country’s legal framework can ensure the effective regulation of the powers, duties and responsibilities of boards. These issues are currently under discussion in Ukraine’s parliament. Market participants expect amendments to certain legislative acts introducing improvements to the corporate governance of legal entities where the principle shareholder is the state.

One key issue for investors is internal control and risk management. Naftogaz Group is introducing internal controls that include such important areas as internal audit, risk management, financial control, compliance and investment management. In line with this strategy, Naftogaz is the first state-owned company in Ukraine to develop and approve a Risk Appetite Statement. Such positive changes give rise to optimism that the replacement of old and inefficient statutory controls can yet become the dominant trend among Ukrainian SOEs.  


Better Business Culture

The quality of the legal framework in a country is crucial for corporate governance, but so is the quality of the business culture within individual companies. Ethical investors pay significant attention to a company’s values. Management guru Peter Drucker famously says that culture eats strategy. In other words, even the most brilliant business strategy in the world will not bring success to a company if bad governance culture is in place.

Ukraine’s corporate culture features many inherited Soviet values and behavioral norms that are quite different to the contemporary European values and norms that determine how employees in the EU tend to behave. A company that puts systems before people operates differently from a company that puts people before systems. Ukrainian company executives should invest their transformation energies into building a new corporate culture in order to make sure they are fostering the kind of human dimension upon which every company must depend. Business leaders should work hard to shape employee values, beliefs and behaviors.

One of the key indicators that helps in the assessment of changes to corporate culture is how employees of a company deal with one another and their external counterparts. Building a corporate culture is primarily the responsibility of a company’s executives. The current trend within Ukrainian energy companies towards adopting corporate ethics codes is certainly a good sign for investors. A code of corporate ethics establishes a new ethical framework in which employees operate. Any ethical framework is beneficial for a company if implemented effectively. It must also be credible. The daily lives of business leaders must meet with the underlying principles of any ethics code.  


Establishing Public Trust

During a time of global energy market transformation, the issue of public trust is becoming especially important. Everyone today is familiar with trendy sloganeering like “Shifting to low-carbon economies will satisfy your health and safety concerns”. People want to understand how and when energy decision makers, governments, regulators and energy companies are going to implement these tasks. Energy consumers want to be informed and engaged in the transition process.

Levels of public confidence in energy companies can differ from country to country. The causes of distrust may also be different. A few years ago, an online survey by the Canada West Foundation detected that “while Western Canadians recognize the importance of the energy sector to the economy, there remains a high level of distrust of the oil and gas industry.” The main reason for this lack of trust was the perception that profit orientation was the only orientation of the energy industry. Based on the results of this survey, demonstrations of social and environmental responsibility can help energy companies to build public acceptance and confidence.

Much like their counterparts around the world, Ukrainian energy companies need to work on building public trust. One of the main criteria energy consumers and local communities use relates to the positive benefits they can receive and potential negative impacts on their lives. Meanwhile, many ethical investors use Environmental, Social and Governance (ESG) Criteria to screen potential investments. The energy industry enjoys a much better chance of successful development if it takes the demands and expectations of its main stakeholders into account. If state authorities and energy companies enjoy greater public trust, they are able to gain all-round support for different energy projects.


Attractive to Investors

A strong and effective corporate governance strategy is a critical factor in all investment decisions. Investors take a close look at how companies manage themselves and how they establish their relationships with their main stakeholders. A high level of transparency is very important since it can ensure that companies use high quality accounting, disclosure, compliance and auditing standards. One of the main challenges facing the energy industry worldwide today is trust. Investors increasingly focus on how good governance culture forms and how productive relationships with stakeholders develop.

High quality corporate governance can encourage investors to make their final investment decisions. This in turn means that strengthening governance practices can help Ukrainian energy companies attract investments and prosper in the global marketplace. The good news is that corporate governance reform is on Ukraine’s agenda. Positive results from this reform process can influence how investors behave when deciding whether to invest in the Ukrainian energy sector. 

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