What should Kyiv do with its municipally-owned enterprises?

Kyiv is the wealthiest and largest city in Ukraine; therefore, it spends considerably more funds on municipally-owned utilities than other cities. In 2020, the estimated revenues Kyiv municipally-owned enterprises received by fulfilling government orders were UAH 5 billion.

UAH 10.6 billion was spent on financing capital investments through Kyiv municipally-owned enterprises, which equals 18.33% of Kyiv’s budget expenditures. However, 90% of these 10.6 billion were spent on 15 MOEs, including those which fulfil an important social function,  such as Kyivzelenbud, Kyivpastrans, Kyivteploenergo, and those that act as procuring entities for construction and other works – the funds pass through them and are distributed among contractors.

As of the end of 2020, there are 128 operating commercial MOEs in Kyiv. Most of them are profitable, but they cannot be regarded as efficient because their profits are minimal compared to the resources used to generate them. In addition, the city has shares in 22 companies, including PJSC Holding Company “Kyivmiskbud”, PJSC Kyivspectrans, PJSC “Kyivvodokanal“, JSC Kyivgas, PJSC Company “Kyivenergoholding” (which holds shares in other city companies).

Problems of MOE in Kyiv

MOEs are operating in non-relevant sectors. The rationale for municipal ownership is theoretically the existence of “market failures” – when the company is a natural monopoly or performs an important social function, which the market cannot provide. Instead, at least 43 MOEs in Kyiv provide services in sectors where private companies are present.

In particular, district motor transport enterprises, some MOEs in mass media, culture, and sports; most investment and construction companies; service companies in the district subordination; markets; school caterers; MOE “Farmatsia”; MOEs that are subsidiaries of Kyivavtodor, which are not road assets holders.

Another 18 MOEs perform particular administrative functions of the executive body: three MOEs that influence public image (for example, the Kyiv Investment Agency), some MOEs with procuring function, five service MOEs (Centre of Transport Management, Kyivreklama, Kyivekspertiza, etc.), and 4 MOEs that organize fairs.

Unstable financial condition. Kyiv’s municipally-owned enterprises are unprofitable and cannot generate enough revenues, requiring regular subsidies from the budget and/or orders from the city. Only 12 out of 128 companies analyzed have ROA exceeding 3%.

Only one MOE out of the top 15 recipients of the budget funds (MOE Kyivkommunservice) has a high level of profitability, both in 2020 and in previous years.

Others are either unprofitable (MOE Kyivpastrans, MOE Kyiv Metro, which still receive subsidies to ensure break-even level for operating) or have almost zero profitability. Kyiv Metro has the highest total losses (over UAH 1 billion), but its relative loss ratio is not critical (-2.3%).

Most MOEs areas profitable (100 MOEs in 2020), according to their financial reports. Still, in the financial statements, most of them have large operating losses, which are then offset by other revenues – so that the MOE shows a marginal profit. However, for the private sector, this situation could indicate a core business issue.

For municipal enterprises, the cause of significant operating losses is often the amount of depreciation, accrued on property received for free from KCSA, which is added to operating expenses. This depreciation is also included in other revenues under the accounting rules and thus does not affect profits.

The downside of this policy is that by not creating requirements and incentives for municipal enterprises to increase profitability and increase their self-financing levels, the authorities are effectively taking over the capital needs of the utilities now and in the future. And with a lack of budget funding, municipal enterprises are at risk of being underfunded.

Insufficient communication with customers, suppliers, and the founder. Of the 128 MOEs analyzed, about half (63) do not have a website. Only 44 enterprises update information on their website (34% of the analyzed MOEs at the time of the analysis had information on the website not older than three months). Although MOEs publish financial reports on the Kyivaudit portal, there is no mechanism for public standardized reporting by MOE managers to evaluate financial and non-financial KPIs (except for semi-annual special evaluation committee meetings and manager evaluation on a “satisfactory/unsatisfactory” scale).

Low procurement efficiency. While essentially municipal enterprises use the city’s money, not all do so transparently. Not all enterprises use Prozorro for procurement – because they do not consider themselves procuring entities as defined by the law.

Moreover, even those who use Prozorro need additional training or external supervision. For example, the utility company Managing Company for Housing Maintenance of Svyatoshynskyi District in Kyiv attempted to procure goods and services based on the “local content” criterion and entered it into 101 tenders.

However, the decision to apply this criterion was only adopted by the KCC in the first reading in July 2020. Still, it was immediately blocked by the Antimonopoly Committee – and did not come into effect.

Two of the largest MOEs in Kyiv – Kyivpastrans and Kyivteploenergo had the highest percentage of procurements with irregularities identified by the State Audit Service among the MOEs analyzed.

Some MOEs de-jure compete in tenders but are, in fact, the leading suppliers of goods or services to public institutions that could have purchased them from private companies.

For example, DSAs (district state administrations) may include discriminatory procurement terms in tenders for school catering services, favouring municipal enterprises. To ensure that MOEs win, RSA may reject other proposals, and cancel tenders. The formally profitable MOE Farmatsia accounts for a significant share of revenues through procurement by public hospitals.

Among the top 15 MOEs by the amount of funding received from the budget, only three (MOE Kyiv Metro, MOE Kyivbudreconstruction, and MOE Zhytloinvestbud-UKB) had a higher-than-average procurement efficiency result in Prozorro in 2018-2020. Kyivkomunservis has shown the worst results.

Risks of corruption. Kyiv’s municipal companies have a poor reputation, as they regularly appear in journalistic investigations and criminal corruption cases.

Among the 128 MOEs studied, 79 have been the subject of publications over the past four years, and 61 have been the subject of court cases (criminal proceedings).

The cases mainly concern procurement irregularities and schemes of embezzlement and misappropriation of public funds. Only 25 MOEs have carried out at least some work to identify and minimize corruption risks in their activities.

Kyivaudit (the Department of Internal Financial Control and Audit) effectively responds to abuses: the audits (including those of MOEs activities) identified financial irregularities worth UAH 445.3 million in 2018, UAH 2.3 billion in 2019, and UAH 274.8 million in 2020. However, given the significant number of MOEs, the department does not have sufficient capacity for appropriate oversight: only 25 MOEs have been audited since 2018.

Imperfect system of appointment and reporting of managers. About a third of municipal enterprises studied have changed directors twice or more in the last four years. The reasons for this situation can be both corruption scandals and other circumstances. Either way, it harms the stability and development of enterprises.

In 24 MOEs, for the last four years, the managers have been acting managers for a long time, while essential MOEs such as Informatika, Kyivzelenbud, or Kyivtransparkservis have not had a full-fledged manager for more than 2.5 years during 2017-2020. This situation carries risks of managerial incompetence, opportunistic behaviour, and a lack of strategic decision-making in favour of short-term decisions.

Corporate governance reform has been delayed. The Kyiv City Council and KCSA have been trying to introduce a supervisory board mechanism in the city’s largest municipal enterprises since October 2016. As of April 2021, framework decisions have been taken, and only Kyivteploenerho has formally established a supervisory board (but no independent members have been elected). Kyiv municipally-owned enterprises are not managed according to OECD Guidelines. MOEs in competitive sectors have not been privatised in recent years either.

Recommendations to KCC and KCSA

The measures we recommend resulting from the study can be divided into strategic and tactical (short-term).

Strategic measures should aim to reduce the portfolio of MOEs and bring the management of remaining companies in line with OECD Guidelines on Corporate Governance of State-Owned Enterprise (corporatization and corporate governance reform).

Adopt a city ownership policy and review it regularly. The city government seeking to manage assets effectively should develop and approve a city ownership policy for the municipal enterprises and individual ownership policies for each MOE (pursuance of the Kyiv City Development Strategy 2025 and legislation obliging local governments to develop competition).

The ownership policy should contain precise requirements for the sector, objectives, and functions for each MOE that is to remain owned by the city.

Based on the city’s ownership policy, conduct a “triage”. The Standing Committee on Property and the relevant departments of the Kyiv City State Administration, together with independent experts, should categorize the city MOEs into groups depending on whether they should remain in municipal ownership and in what organizational and legal form.

A strategic vision for a portfolio of enterprises in municipal ownership should be formed, which would consist of a small number of capable joint-stock companies in certain areas (natural monopolies and services of general economic interest).

Privatize as many MOEs and shareholdings in companies operating in competitive markets as possible (including profitable) and do not establish new ones. It is estimated that at least 50 commercial MOEs in various sectors operate in highly competitive markets.

Reorganize those MOEs that perform administrative functions, duplicate each other’s roles and corporatize the structures of Kyivavtodor and Kyivzelenbud with the publication of consolidated financial statements.

Establish public-private partnership mechanisms or effective supervisory boards in the enterprises that are natural monopolies or provide services of general economic interest. In particular, we recommend making comprehensive amendments to Kyiv City Council Decision of December 19, 2019 №495 / 8068 “On some issues of management of enterprises belonging to the municipal property of the territorial community of Kyiv”: to give supervisory boards real powers to appoint heads of MOEs and JSCs in the city ownership, introduce transparent and detailed practices for the election of independent members of supervisory boards and set requirements for their qualifications, etc.

Tactical measures aim to improve the management of the municipal enterprises’ portfolio by the founder, to create conditions for increasing the efficiency of existing MOE and their accountability to the city authorities and citizens.

Improving the efficiency of procurement. Working with market participants and taking measures to attract as many participants as possible to participate in the MOE procurement. Such measures may include prior market consultations with market participants and inviting them to participate in procurement procedures.

Therefore, developing and approving the Kyiv City Council regulations on conducting preliminary market consultations and introducing such practices to MOE heads is advisable.

The Kyiv City Council should not make decisions that may later be considered discriminatory against potential participants in public procurement procedures.

Budget financing  optimisation. The city authorities should calculate the economic effect of all budget allocations to the MOE and make decisions on allocating funds to the municipal enterprises based on economic impact indicators.

It is worth considering the possibility of bank lending instead of obtaining budget financing. It would also be worth getting rid of redundant assets or using them to generate income.

Strengthen prevention corruption instruments. Amendments to the Anti-Corruption Programs of enterprises should be made, taking into account information on already identified corruption issues.

Overestimation of the cost of works, discrepancies between performed and declared works, fictitious contracts to withdraw funds from the enterprise and their further appropriation, numerous manipulations of tender procedures, extortions are among some of the examples of changes that should be made.

To effectively combat corruption, Kyivaudit’s ability to detect abuses should be strengthened. Regular publication of all available data on MOEs and their managers and their annual reports, including an open data format, would allow public expertise in analyzing management decisions.

Improve the system of appointment of directors. It is recommended: 1) to develop a clear and transparent procedure for rejecting candidates or 2) to remove the clause which allows the mayor to reject both candidates proposed by the commission from the Regulations on Competitive Selection of Heads of the Public Utility Sector of the Economy in Kyiv.

Public reporting and KPI for managers.  The obligation to publish unified annual reports of MOE managers and the practice of public reporting by them should be introduced; An assessment of their actions based on pre-defined public KPIs must be made.

For managers of natural monopolies and MOEs that perform a social function, cost-effectiveness, return on investment, solvency indicators, asset turnover indicators, together with industry-specific indicators, should be introduced as KPIs. The KPI system should also be linked to procurement performance indicators.

Improving the management of MOE Kyivteploenerho. The company should obtain a professional supervisory board and other elements of corporate governance following the OECD Guidelines to attract investment and successfully pursue cooperation with international financial institutions.