Gatekeeper to private sector investments in Ukraine

The government of Ukraine has announced its intention to centralise the governance of its public commercial assets (companies and real estate owned by the government).

This is very welcome news since the government-owned commercial sector in Ukraine is a large part of the economy. It is paramount that such an important sector is brought under professional governance, to the benefit of society as a whole. However, complicating the process with unproven ideas, such as land banks and investment funds or leaving the government to handle divestitures, will only lead to an opaque restructuring of the sector resulting in an undue transfer of public wealth to the private sector

Good leadership requires good information to support smart, timely decisions. More fundamentally, modern democracy itself relies on information that can be understood and trusted by its citizens and interpreted by all stakeholders. Nowhere is this more important than in the management of our public resources.

The success of Ukraine's economic recovery and growth will largely depend on private sector investment flows, which, in turn, rely on a transparent and level playing field free from the dominance of state-owned companies driven by political agendas. Given the scale of the state-owned sector and its presence in many competitive industries such as energy, transport, finance, manufacturing and real estate, private investment will seek assurance that the state portfolio operates on strictly commercial grounds without policy-driven biases, unfair advantages, or market distortions.

Transforming the governance and management of public commercial assets will consequently be the gateway to broader investment in the country and its future development as a sustainable market economy. Introducing professional management of public commercial assets can transform how business is done in Ukraine, be a driver of economic growth and fiscal space, and help adopt European business practices that prioritize transparency and accountability.

Demonstrating Ukraine's ability to help fund its own reconstruction will also be crucial to ensuring efficient utilization of international donor funds and avoiding waste.

Due to the obvious conflict of interest in its role as a regulator and owner of commercial assets, the government would benefit from placing the portfolio of assets in a separate eco-system - a Public Wealth Fund (PWF), such as that of Temasek in Singapore.

Importantly, a PWF should be at an arms-length distance from the regulatory role of line ministries, focusing on value maximization as a tool to help improve public net worth (assets minus liabilities). IMF research clarifies that governments with stronger net worth recover faster from recessions and have lower borrowing costs.

Framing the transformation process in financial terms with clear targets and timelines proves more effective than viewing it solely as a corporate governance reform. The Ministry of Finance should be held solely responsible and accountable as the official owner of the PWF. The PWF would thereby act as a financial instrument to generate additional revenues for the government, improve debt sustainability and ultimately lower the government's capital cost.

This differs from a Sovereign Wealth Fund (SWF) such as the GIC in Singapore, which is primarily concerned with managing reserve liquidity, typically investing in securities traded on major mature markets. SWFs are designed to optimize a portfolio by trading securities to balance risk and returns and not seldom under the custodianship of the central bank.

A PWF is like fire – it can be a powerful force for good but can also do great damage. Temasek is perhaps the best example of a force for good, with a compounded and annualised return of 14 per cent since its inception in 1974. Together with GIC, it has strengthened Singapore's net worth for the benefit of future generations and moved the economy from a developing to a developed economy in a single generation. Ukraine would do well to model its PWF after Temasek and Singapore rather than on resource-rich countries that use PWFs to diversify their economy from their dependence on commodities.

In the wrong hands, a PWF can fail in its ambition to deliver fiscal space and economic growth, as the PWF in Greece set up after the GFC, or be used against society, such as in the case of the many such funds controlled by the military in countries such as Egypt, Pakistan, and Myanmar. The 1MDB, the PWF of Malaysia, is another example where more than US$4.5 billion was diverted to benefit government officials, including prime minister Najib Razak.

This is why such a powerful tool requires a robust network of stakeholders and safeguards to prevent misusing it. International involvement is vital to ensure the holding structure's correct establishment and support reformers within the Ukrainian administration. Utilizing capital markets would encourage transparency and attract international investors.

All assets benefit from a commercial framework to help optimise their most effective use. Rationalising and focusing this portfolio involves determining which assets have reached a fair value and would benefit from timely disposal rather than being further developed. This is only possible inside a holding company so that any disposal can be done at the best point in the relevant market cycle as part of the broader business plan to maximise the yield across the entire portfolio.

Any compromise in the fundamental pillars of good governance for public commercial assets - including transparency, clear objectives and political insulation - would instantly translate into lower returns for the portfolio and the individual assets. It would also result in a ‘political’ discount on the price a potential investor would be prepared to pay when considering investing in a government-linked asset, as it would not be seen as fully commercial.

Rethinking how the government view its public assets is now a moral as much as an economic goal. Making this change will be difficult, but the evidence is clear – sustainable management through a professional Public Wealth Fund can deliver enormous benefits to society as a whole.

Dag Detter is the principal of Detter & Co, an advisor to governments, investors and IFIs such as the IMF, World Bank and The Asian Development Bank. He led the restructuring of the Swedish portfolio of state-owned assets and is the author of the Public Wealth of Nations – the Financial Times and The Economist ‘Best Book of the Year’ 2015.