16 FEBRUARY 2024
Newsletter 23
WARTIME REFORMS AND INSTITUTIONS. KEY ACTORS
INTERNATIONAL COOPERATION
The US: Biden strives to overcome Ukraine aid impasse in Congress with other measures:
- On February 14, the US Senate passed the 95 billion dollar bill for military assistance to Ukraine, Israel and Taiwan, over 60 billion of which are destined for Ukraine. Next, the bill has to be approved by the House of Representatives, but for now, the House Speaker Mike Johnson is refusing to put the bill to vote in a procedural move which reflects Trump-driven opposition to allies assistance and may delay the vote on critical aid for Ukraine indefinitely. Russia enjoys the advantage in troops and weapons on the battlefield.
- Joe Biden has also requested Congress approval for $11.8 billion in budget support to Kyiv.
- At the same time, the US made a move on Russian assets confiscation when on January 23, the US Senate Foreign Relations Committee voted for the "Rebuilding Economic Prosperity and Opportunity (REPO) for Ukrainians Act. "If approved by Congress and signed by the US President into law, it would be a foundation for the process of seizure of Russian assets, establishing an important international precedent. However, since over 200 out of near 300 billion dollars worth of Russian assets sit in the EU, while only a fraction of the total is in the US. Thus, its European reaction to this precedent which can make a difference (or not)".
- The Pentagon will transfer American high-precision ground-launched small-diameter bombs (GLSDB) to Ukraine without specified terms. The GLSDB will allow the Ukrainian military to hit targets at twice the distance as HIMARS missiles. The GLSDB transfer is an alternative to ATACMS missiles, which the US has provided in small numbers.
The EU shows itself a more reliable ally for Ukraine:
- In contrast to the US debacle, on February 1, the European Council approved a much-awaited 50 billion euros of non-military assistance to Ukraine at the Brussels summit. The amount is to last for next 5 years and includes 33 billion in loans and 17 billion in “non-repayable support.” It will be allocated in one lump-sum, which ensures the money from the political risk as the term of Ursula Von der Leyen Commission comes to an end in October 2024. The money arrives at a critical point for Ukraine, when numerous government employees, from doctors and nurses to teachers, have reported going without a salary for at least one month. Over half of Ukraine’s budget depends on foreign assistance.
- On February 2, High Representative of the European Union for Foreign Affairs and Security Policy Joseph Borell announced a further €21 billion, this time of military assistance to Ukraine from the EU in 2024 alone.
National decisions on military assistance to Ukraine:
- During President Volodymyr Zelensky’s visit to Paris on February 16, France and Ukraine are signing a security agreement.
- Denmark announced its decision on February 18 to give all its artillery equipment to Ukraine.
- Belgium has promised 611 million euros of military aid to Ukraine, following a phone conversation between Ukrainian and Belgian Defense Ministers on January 22, 2024.
- Also on January 22, 2024, Polish Prime Minister Donald Tusk visited Kyiv, offering increased military aid and a loan for arms purchases to Ukraine. This shift comes after months of grain import bans and border blockades by Poland. Tusk, having recently negotiated with Polish farmers, is now advocating for joint investments in arms production with Ukraine and pushing for more military assistance within Poland. His support is crucial, especially as the EU has failed to deliver on its pledge of one million artillery shells in 2023.
- Germany will hand over six decommissioned Sea King Mk41 multipurpose military helicopters to Ukraine. The German side will also provide training for the Ukrainian military, German Defense Minister Boris Pistorius announced following the 18th meeting in the Ramstein format.
- Ukraine, Latvia, UK, Sweden will create a Drone and Electronic Warfare Coalition, which will be joined by allied countries.
- Canada announced a new $15 million military aid package for Ukraine in January.
- The Kuwaiti authorities are considering sending more than 100 M-84AB tanks (a modification of the Soviet T-72M) to Croatia for repair and modernization with subsequent transfer to Ukraine.
- Japan could not implement a plan developed in conjunction with Britain to supply shells to Ukraine. The country was supposed to produce 155 mm shells under a license from the British company BAE Systems and then send them to Britain. However, the UK plans to compensate Ukraine for the supply of shells.
Ukraine’s energy sector developments:
- Ukraine’s Minister of energy Herman Halushchenko announced the intention to start construction of Khmelnytsky 3 & 4 nuclear reactors (more than half finished by 1991, then abandoned since the fall of the Soviet Union) in the summer or fall 2024. These are soviet design reactors, and to complete them Energoatom plans to use Russian equipment to be purchased from Bulgaria (also home to Russian nuclear power plant Kozloduy). In addition, Westinghouse has reiterated its plans to build two new nuclear reactors on the Khmelnytsky site, without mentioning the start date.
REFORM IN FOCUS: UKROBORONPROM CORPORATE REFORM
In Newsletter 22 we have discussed Ukraine’s defense procurement reform. In this newsletter we explore the corporate reform of the "Ukrainian Defense Industry," or former “UkrOboronProm”, the reasons behind it, why it is important, and what it may change in making Ukraine’s defense industry more transparent and attractive for foreign partners.
UrkOboronProm as a post-soviet legacy
After the collapse of the Soviet Union, independent Ukraine retained about 30% of the USSR military-industrial complex, or over 750 enterprises and organizations. This meant that despite Ukraine’s independence, the military industries of Russia and Ukraine remained interdependent after 1991. The 1990’s and early 2000’s were also characterized by a massive sell-off of the soviet-era military equipment, generating important and unregulated cash flows. When, propped by Russian support, Victor Yanukovich became president in 2010, he decided to centralize these cash flows under his reign by uniting numerous defense industry companies into a state holding company UkrOboronProm (UOP). The centralization of cash flows facilitated the sell-off of equipment without modernizing production, undermining Ukraine’s military capacity.
Source: РБК
The UOP business units were structured around 5 areas:
1) aircraft construction and aircraft repair,
2) high-precision weapons and ammunition production,
3) manufacturing of armored, automotive, engineering, and special vehicles,
4) shipbuilding and marine equipment,
5) radar, radio communications, and air defense systems.
However, the UOP holding was vested in the legal structure of a “concern”, another soviet legacy incompatible with Western corporate structures, creating inherent and real concerns around doing business with UOP through partnerships or investment.
After adjusting the Constitution, President Yanukovich and his Prime Minister held full control over the defense industry through direct appointment of the UOP head, although technically the company was subordinate to the Cabinet of Ministers. Thus, UOP became a money laundering machine for Yanukovich, de facto unaccountable to anyone but the president and distraught from its mission to strengthen defense industry, with fatal consequences for the sovereignty of Ukraine since the first Russian invasion of its borders in 2014.
After the Maidan Revolution of 2014, UOP fell under scrutiny of Ukraine’s civil society, where actors such as NAKO created pressure on the Presidential Administration and the Ministry of Defense for more transparency in the sector. They were supported by foreign partners who demanded greater accountability for the military assistance they were providing to Ukraine. In response to these demands, Petro Poroshenko elected president in 2014 announced the creation of a legal framework for UOP reform. However, the first international audit of UOP was conducted in 2019, 5 whole years after the legal framework was adopted.
1) aircraft construction and aircraft repair,
2) high-precision weapons and ammunition production,
3) manufacturing of armored, automotive, engineering, and special vehicles,
4) shipbuilding and marine equipment,
5) radar, radio communications, and air defense systems.
However, the UOP holding was vested in the legal structure of a “concern”, another soviet legacy incompatible with Western corporate structures, creating inherent and real concerns around doing business with UOP through partnerships or investment.
After adjusting the Constitution, President Yanukovich and his Prime Minister held full control over the defense industry through direct appointment of the UOP head, although technically the company was subordinate to the Cabinet of Ministers. Thus, UOP became a money laundering machine for Yanukovich, de facto unaccountable to anyone but the president and distraught from its mission to strengthen defense industry, with fatal consequences for the sovereignty of Ukraine since the first Russian invasion of its borders in 2014.
After the Maidan Revolution of 2014, UOP fell under scrutiny of Ukraine’s civil society, where actors such as NAKO created pressure on the Presidential Administration and the Ministry of Defense for more transparency in the sector. They were supported by foreign partners who demanded greater accountability for the military assistance they were providing to Ukraine. In response to these demands, Petro Poroshenko elected president in 2014 announced the creation of a legal framework for UOP reform. However, the first international audit of UOP was conducted in 2019, 5 whole years after the legal framework was adopted.
The UkrOboronProm corporate reform since 2019, and why it took so long to implement:
On 21 March 2023, Ukraine’s Cabinet of Ministers announced the transformation of the state “concern” "UkrOboronProm" into a Joint Stock Company "Ukrainian Defense Industry" (UDI). The UDI holding company in turn will consist of numerous Joint Stock Companies organized by business area. The main difference from the previous business structure, consisting of 137 enterprises within the UkrOboronProm “concern”, is the shareholding nature of every UDI enterprise, making each UDI company, from plane to missile production to maintenance to spare parts production, compatible with any Western counterpart. So far, 28 out of 137 earlier UOP enterprises have been corporatized, with 10 more in progress.
The Ministry in charge of developing and overseeing defense industry policies, and thus in charge of UDI, is the Ministry of Strategic Industries. Innovation and technological progress are the main missions it sees for UDI. With the name change from UOP to UDI came a new CEO, appointed by the Cabinet of Ministers of Ukraine: a leading UOP engineer Herman Smietanin.
UDI 6 key business areas include: aircraft construction and maintenance, high-precision weapons, ammunition and special chemicals, armored vehicles, radar, and naval systems. Drones should be added as a sixth area. The business priority is to develop international partnerships for joint production in or for Ukraine.
The Ministry in charge of developing and overseeing defense industry policies, and thus in charge of UDI, is the Ministry of Strategic Industries. Innovation and technological progress are the main missions it sees for UDI. With the name change from UOP to UDI came a new CEO, appointed by the Cabinet of Ministers of Ukraine: a leading UOP engineer Herman Smietanin.
UDI 6 key business areas include: aircraft construction and maintenance, high-precision weapons, ammunition and special chemicals, armored vehicles, radar, and naval systems. Drones should be added as a sixth area. The business priority is to develop international partnerships for joint production in or for Ukraine.
The corporatization of UDI is important for three main reasons:
1) Turning UDI into a Joint Stock Company equips it with a modern corporate structure understandable to Western businesses and adapted (in contrast with the “concern” legal structure) to partnerships with foreign firms to maximize and improve weapons production.
2) While UDI remains 100% state-owned, corporate structure allows for mergers within the corporation, potentially reducing inefficiencies. In the mid- to long-term, the new shareholding structure allows for future investment by domestic and foreign investors, with a potential for privatization.
3) Western corporate structure also brings internal “checks and balances” system through three management bodies: the management board, the supervisory board, and the state as the only shareholder (for now). This management structure is meant to avoid the concentration of control over the corporation in the hands of the sole figure of Ukraine’s president, as has been in the past. For example, instead of being appointed the President, the CEO should be selected by the Supervisory Board and the Cabinet of Ministers. While among the people appointing Supervisory Board members are prominent members of Ukraine’s civil society acting through the Anti-Corruption Commission, from within the MoD.
The caveat to this third point of the reform today is that this new system of management appointments should take place only after the war. Under the marshal law, the CEO is appointed only by the Cabinet of Ministers. However, the choice of the new UDI CEO Herman Smietanin (see person of the month section) is a positive sign in itself.
1) Turning UDI into a Joint Stock Company equips it with a modern corporate structure understandable to Western businesses and adapted (in contrast with the “concern” legal structure) to partnerships with foreign firms to maximize and improve weapons production.
2) While UDI remains 100% state-owned, corporate structure allows for mergers within the corporation, potentially reducing inefficiencies. In the mid- to long-term, the new shareholding structure allows for future investment by domestic and foreign investors, with a potential for privatization.
3) Western corporate structure also brings internal “checks and balances” system through three management bodies: the management board, the supervisory board, and the state as the only shareholder (for now). This management structure is meant to avoid the concentration of control over the corporation in the hands of the sole figure of Ukraine’s president, as has been in the past. For example, instead of being appointed the President, the CEO should be selected by the Supervisory Board and the Cabinet of Ministers. While among the people appointing Supervisory Board members are prominent members of Ukraine’s civil society acting through the Anti-Corruption Commission, from within the MoD.
The caveat to this third point of the reform today is that this new system of management appointments should take place only after the war. Under the marshal law, the CEO is appointed only by the Cabinet of Ministers. However, the choice of the new UDI CEO Herman Smietanin (see person of the month section) is a positive sign in itself.
Source: Slovo i Dilo
How can these changes help fight corruption?
In his recent interview, the new CEO pointed out 3 corruption risks in the defense industry he aims to fight with the following methods:
● Bribery for high-position appointments with a merit-based competition system.
● Inflated prices for the company market with Prozorro state e-procurement system.
● Reduced rent for public land to cronies with Prozorro Sale contracts.
On the legal level, UDI, its patron Ministry of Strategic Industries of Ukraine and the NAPC (the National Anti-corruption Agency of Ukraine) have developed a larger anti-corruption framework: the Strategy for Preventing, Detecting and Combating Corruption, presented in September 2023. The strategy is based on the UN Convention against Corruption, OECD recommendations, NATO's Building Integrity Policy, reports from the NAPC, and the recommendations of Ukraine’s anti-corruption NGO’s (such as NAKO, Together Against Corruption and StateWatch).
● Bribery for high-position appointments with a merit-based competition system.
● Inflated prices for the company market with Prozorro state e-procurement system.
● Reduced rent for public land to cronies with Prozorro Sale contracts.
On the legal level, UDI, its patron Ministry of Strategic Industries of Ukraine and the NAPC (the National Anti-corruption Agency of Ukraine) have developed a larger anti-corruption framework: the Strategy for Preventing, Detecting and Combating Corruption, presented in September 2023. The strategy is based on the UN Convention against Corruption, OECD recommendations, NATO's Building Integrity Policy, reports from the NAPC, and the recommendations of Ukraine’s anti-corruption NGO’s (such as NAKO, Together Against Corruption and StateWatch).
Results since 2023:
1) UDI established a Supervisory Board made of 5 independent experts, including 3 state representatives:
2) The above civil society representatives, from anti-corruption NGO’s, were given an institutional role within the Anti-Corruption Commission embodied within and working closely with the MoD on supervising and making recommendations on processes from procurement to the UDI Supervisory Board appointments.
3) Property management policies update for defense companies to enhance efficiency and accountability in resource allocation.
4) UDI’s first Joint Venture with the German Rheinmetall AG, “Rheinmetall UDI”, signed on October 18, 202, for the the maintenance and repair of armored vehicles, joint production of Rheinmetall products, and the development of new weapons and equipment – all of it in Ukraine.
- Tymofiy Mylovanov, President of the Kyiv School of Economics and former Minister of Economy;
- David Lomjaria, member of the Supervisory Board of Ukrzaliznytsia and former CEO of Iberia Refreshments PepsiCo;
- Lindy Smith, President and CEO of the Arizona Defence Industry Coalition)
- Sergiy Konovets, former member of the Supervisory Board of UkrExImBank and the Board of Naftogaz of Ukraine;
- Oleksiy Honcharuk, former Prime Minister of Ukraine and Chairman of the Supervisory Board of AeroRozvidka.
2) The above civil society representatives, from anti-corruption NGO’s, were given an institutional role within the Anti-Corruption Commission embodied within and working closely with the MoD on supervising and making recommendations on processes from procurement to the UDI Supervisory Board appointments.
3) Property management policies update for defense companies to enhance efficiency and accountability in resource allocation.
4) UDI’s first Joint Venture with the German Rheinmetall AG, “Rheinmetall UDI”, signed on October 18, 202, for the the maintenance and repair of armored vehicles, joint production of Rheinmetall products, and the development of new weapons and equipment – all of it in Ukraine.
he full-scale invasion prompted UkrOboronProm to start reforming for the first time, with a corporate structure favorable to partnerships, a new management structure, a shareholding legal structure allowing for potential future privatization, and an anti-corruption strategy. However, concerns linger regarding the lack of clear safeguards against political interference and accountability, which remain impossible during the war. Continuous monitoring is essential for a sustainable reform and results, crucial in the face of belligerent Russia.
PERSON OF THE WEEK: CEO OF UKRAINIAN DEFENSE INDUSTRY HERMAN SMIETANIN
In late June 2023, Herman Smietanin, a UOP engineer, at 31, was appointed the CEO of Ukrainian Defense Industry (former UkrOboronProm). He has 3 priorities, defined by the Ministry of Strategic Industries: increase the production of ammunition, build anti-corruption structures inside the company, and transform UOP into a modern corporation.
A graduate of Kharkiv National Automobile and Highway University with a degree in engineering and of the National Technical University with a degree in management, he brings a combination of technical ability and organizational potential required for his new role. During his 10 years at the company, Smietanin rose through the ranks from an inventor engineer to the head of Malyshev production plant in Kharkiv. He was noticed by his management and later by Oleksandr Kamyshin, Minister of Strategic Industries, who recommended him to Zelensky as a leader able to yield results. And the results are needed fast, as Ukraine is going through the ammunition scarcity on the frontlines. Smietanin’s predecessor, former head of UOP Yurii Gusiev, was fired from this position after he “blew the missile program.”
There is an increasing demand for meritocracy in Ukrainian society, and old-generation managers of state corporations have been targeted by critics for years for frequent signs of incompetence, corruption or being out of touch with reality (as a matter of example, former president of Ukraine’s high-tech plane engine producing company Motor Sich, Viacheslav Bohuslaiev, who was fired in late 2023 after being charged with state treason, was born in 1939). Appointing young and sharp Smietanin, with a proven track record of engineering and management achievement, climbing through the ranks of UOP, responds to that demand. He presents the face of a new generation of Ukrainian management, the face of Ukraine Kyiv wants to project to the world.
A graduate of Kharkiv National Automobile and Highway University with a degree in engineering and of the National Technical University with a degree in management, he brings a combination of technical ability and organizational potential required for his new role. During his 10 years at the company, Smietanin rose through the ranks from an inventor engineer to the head of Malyshev production plant in Kharkiv. He was noticed by his management and later by Oleksandr Kamyshin, Minister of Strategic Industries, who recommended him to Zelensky as a leader able to yield results. And the results are needed fast, as Ukraine is going through the ammunition scarcity on the frontlines. Smietanin’s predecessor, former head of UOP Yurii Gusiev, was fired from this position after he “blew the missile program.”
There is an increasing demand for meritocracy in Ukrainian society, and old-generation managers of state corporations have been targeted by critics for years for frequent signs of incompetence, corruption or being out of touch with reality (as a matter of example, former president of Ukraine’s high-tech plane engine producing company Motor Sich, Viacheslav Bohuslaiev, who was fired in late 2023 after being charged with state treason, was born in 1939). Appointing young and sharp Smietanin, with a proven track record of engineering and management achievement, climbing through the ranks of UOP, responds to that demand. He presents the face of a new generation of Ukrainian management, the face of Ukraine Kyiv wants to project to the world.
Herman Smietanin Source: Telegraf
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