Ukraine - Enterprise Development Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6923-UA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED ENTERPRISE DEVELOPMENT ADJUSTMENT LOAN IN AN AMOUNT EQUIVALENT TO US$310 MILLION TO UKRAINE June 3, 1996 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (as of May 30. 1996) Currency Unit = Karbovanets US$1 = 186,000 Karbovanets 1 Karbovanets = US$0.0000054 WEIGHTS AND MEASURES Metric System FISCAL YEAR January I - December 31 ABBREVIATIONS AND ACRONYMS AGSECAL Agricultural Sector Adjustment Loan CAS Country Assistance Strategy CMA Change Management Assistance CPAR Country Procurement Assessment Report CSO Clearing and Settlement Organization EDAL Enterprise Development Adjustment Loan EDP Export Development Project EU/TACIS European Union Program of Technical Assistance for the CIS FIDL Financial Institutions Development Loan GATT General Agreement on Tariffs and Trade GDP Gross Domestic Product IBRD International Bank for Reconstruction and Development ICB International Competitive Bidding IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IPO Initial Public Offering KBV Karbovanets MFERT Ministry of Foreign Economic Relations and Trade MOE Ministry of Economy MOF Ministry of Finance MPP Mass Privatization Program MU Monitoring Unit NASDAQ National Association of Securities Dealers Automated Quotations NBU National Bank of Ukraine NDS National Depositary System OTC Over the Counter PIU Project Implementation Unit SBA Standby Arrangemiient SEC Securities and Exchange Commission SPF State Property Fund SOE State Owned Enterprise SRO Self Regulatory Organization SSMC Securities and Stock Markets Commission STF Systemic Transformation Facility TA Technical Assistance TOR Terms of Reference UNCTAD United Nations Conference on Trade and Development UCPPS Ukrainian Center for Post-Privatization Support USAID United States Agency for International Development USE Ukrainian Stock Exchange VER Voluntary Export Restraint WTO World Trade Organization  FOR OFFICIAL USE ONLY UKRAINE: ENTERPRISE DEVELOPMENT ADJUSTMENT LOAN Loan and Project Summary ............................................. INTRODUCTION ...................................................1 I. BACKGROUND .................................................1 Recent Economic Performance ...................................... 1 Government's Economic Reform Priorities .............................. 2 Enterprise Sector in Transition ...................................... 3 Enterprise Development Adjustment Loan in the Bank's Assistance Strategy ... ...... 5 II. MAINTAINING A COMPETITIVE ENVIRONMENT ......................... 5 External Trade and Tariffs ........................................ 6 Domestic Trade and Prices ....... . ................................ 7 III. GOVERNMENT'S PRIVATIZATION PROGRAM .......................... 8 Mass Privatization of Medium and Large Enterprises ........................ 8 Small-Scale Privatization ........................................ 11 IV. GOVERNMENT'S CAPITAL MARKETS DEVELOPMENT PROGRAM .... ....... 12 Creation of an Independent State Supervisory Body ........................ 12 Promotion of Self-Regulatory Organizations ............................ 12 Regulation ................................................. 13 Transitional Institutional Arrangements ............................... 14 V. DONOR COORDINATION ......................................... 14 General ................................................... 14 EU-TACIS ................................................. 15 U SA ID ......................... ....... ............ ....... 15 Other Donors ............................................... 15 VI. THE PROPOSED LOAN .......................................... 16 Background and Rationale for Bank Involvement ......................... 16 Loan Objectives and Description ................................... 16 Project Implementation and Key Measures for Disbursement .................. 18 Technical Assistance Component for Post-Privatization Enterprise Restructuring ... ... 21 Loan Administration for Investment Component (Technical Assistance) .... ....... 25 Loan Administration for Adjustment Component ......................... 26 Procurement under Investment Component (Technical Assistance) ............... 26 Procurement under Adjustment Component ............................. 27 Disbursement of Investment Component (Technical Assistance) ................ 27 Disbursement of Adjustment Component .............................. 28 Reporting and Auditing ......................................... 28 Project Sustainability ........................................... 29 Lessons Learned from Previous Bank Involvement ........................ 29 This document has a restricted distribution and may be used by recipients only in the performance of their |ofricial duties. Its contents may not otherwise be disclosed wiLhout World Bank authorization. I  Environmental Aspects ............................. 29 Program Objective Categories ........... .................. 29 Benefits and Risks ............................. 29 Recommendation ............................. 30 TABLES Table 1: Summary of Procurement Arrangements ............................... 27 ANNEXES ANNEX 1 Memorandum on Enterprise Sector Development Policy ANNEX 2 Policy Matrix ANNEX 3 Timetable of Key Processing Events ANNEX 4 Status of Bank Group Operations ANNEX 5 The Privatization Process in Ukraine ANNEX 6 Capital Markets in Ukraine ANNEX 7 Technical Assistance Component - Procurement Details ANNEX 8 Ukraine at a Glance ii  UKRAINE: ENTERPRISE DEVELOPMENT ADJUSTMENT LOAN Loan and Project Summary Borrower: Ukraine Implementing Agency: State Property Fund of Ukraine Amount: US$310 million equivalent Terms: Payable in seventeen years, including four years of grace at the Bank's standard variable interest rate. Commitment Fee: 0.75 percent on undisbursed credit balances, beginning 60 days after signing, less any waiver. Poverty Category: n/a Objectives and Description: The main objective of the Loan is to support the Government's trade and price liberalization, privatization, capital markets development and post-privatization restructuring programs. Other objectives are to: (i) provide foreign exchange for the purchase of critical imports; and (ii) support the development of the foreign exchange markets. The reform program to be supported by the loan will include the implementation of a privatization program for 5,000 medium and large enterprises as well as the acceleration of privatization of small scale enterprises and the creation of a legislative framework and institutions to regulate the new capital markets including a Securities and Stock Markets Commission and a self-regulatory organization for market intermediaries. The loan will also finance technical assistance to help with post-privatization restructuring. Benefits: The reforms would put Ukraine irreversibly on the path to a market economy by transferring a critical mass of enterprises from the public to the private sectors, promoting private initiative as the main engine of economic development and growth and providing a competitive environment within which the private sector can flourish. The loan would support the creation and functioning of well regulated capital markets promoting secondary securities trading after privatization, encouraging further ownership consolidation and other post-privatization iii  restructuring and governance improvements and the mobilization of domestic and foreign resources for equity investment. Risks: The main risk is the possible loss of political commitment to reform due to lack of consensus and possible strong opposition from vested interests. Trade and price liberalization and structural reforms strike at the heart of the old centrally planned order. Experience elsewhere, however, has shown that effective and rapid privatization can create a momentum that is very difficult to reverse, especially if the program is designed, as this one is, to promote rapid change and enterprise restructuring and adaptation to the market after privatization. A second risk is that the implementing agencies will not be able to handle a program of this magnitude for which there have been few precedents anywhere. This risk has being minimized by promoting a bottom-up approach to privatization which harnesses the dynamics already at work at the enterprise level and by ensuring that the enterprise employees and population at large are able to participate fully in the program. Judicious use has also been made of technical assistance, both in the loan itself and in the form of grants from other donors to help ease implementation bottlenecks. The final risk is that the level of donor support needed to maintain the reform program in Ukraine is not maintained. This risk will be minimized if the program supported by the loan is successful but the Bank will also keep up its donor coordination efforts to try to ensure continued support for Ukrainian privatization, post-privatization restructuring and capital markets development as the program proceeds. Economic Rate of Return: n/a Project ID Number: UA-PA-35814 This report is based on the work of missions that visited Ukraine between June, 1995 and March, 1996 comprising Messrs./Mmes Bernard Drum (Task Manager), Ana Goshko, Beth Shair, Lieve Vandenhoeck, Angela Prigozhina, Hakan Wilson, Igor Artemiev, Gregory Jedrzejczak, Ritu Anand, Ana Revenga and Alexander Kaliberda. Mmes. Tracy McTernan and Suzanne Coffey provided administrative support and processed the documentation. The peer reviewers were Messrs. Ira Lieberman, Andrew Ewing and Gerhard Pohl. Messrs. Basil Kavalsky and Paul Siegelbaum are the Department Director and Managing Division Chief, respectively. iv  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED ENTERPRISE DEVELOPMENT ADJUSTMENT LOAN TO UKRAINE INTRODUCTION 1. I submit for your approval the following report and recommendation on a proposed Enterprise Development Adjustment Loan to Ukraine for the equivalent of US$310 million. The loan would be at the Bank's standard variable interest rate with a maturity of seventeen years, including four years of grace. I. BACKGROUND Recent Economic Performance 2. After Ukraine declared its independence in August 1991. economic conditions deteriorated dramatically. Between 1990 and 1994, recorded output dropped by a cumulative 50 percent, inflation surged to over 10,000 percent in 1993, and the stock of external debt (including arrears) mounted from zero in 1991 to US$ 7.2 billion by end-1994. Particularly hard hit were energy-intensive industries and those facing shrinking markets for their products, such as the defense-related industries. Because domestic sources provided only about half of the country's energy needs, the adjustment of imported energy prices to world levels implied a sharp terms-of-trade shock, which led to shortages, supply disruption, and accumulation of payment arrears. Only the informal sector of the economy has consistently grown since independence, providing a cushion against the impact of the output collapse. 3. In October 1994, a newly elected president Kuchma announced a radical break from past economic policies and outlined a program aimed at reducing inflation, improving living standards, and promoting a sustainable recovery. In support of the Government's economic program, the IMF approved, in October 1994, a first purchase under the Systemic Transformation Facility (STF) of US$365 million, and the World Bank approved, in December 1994, a Rehabilitation Loan of US$ 500 million. The second purchase under the STF (US$365 million) and a Standby Arrangement (SBA) for the maximum 100 percent of quota (US$1.5 billion) were approved by the IMF in April 1995. 4. For the first nine months of the program, performance was strong: fiscal and credit policies were considerably tightened and inflation fell sharply from monthly rates of 20 percent in early 1995 to around 5 percent during April-August 1995; foreign exchange restrictions were largely abolished and anti-export incentives diminished with, as a result, exports to western markets expanding strongly and the exchange rate stabilizing; most price controls were removed, except on some foodstuffs and communal services which prices were adjusted to increase the share of costs recovered; and energy prices were raised to world levels. The legal basis for privatization was put in place, and initial steps taken in areas such as land reform and restructuring of the energy sector. 1  5. In the second half of 1995, however, there were slippages in implementation of both the stabilization and structural reform programs. The Government renewed various forms of financial support to enterprises, including through direct budgetary lending. The targets of the stabilization program were not met. There were overruns in government expenditures as the Government granted generous wage increases and recommenced subsidizing the coal sector. Banking system credit exceeded program levels, and external payment arrears were incurred by the Government, both on payments for gas imports and on foreign debt service obligations. After several months of single digit inflation, monthly inflation in September, 1995 jumped to 14.2 percent. This reflected, in part, the effects of increases in administered prices for communal services and housing, but also appears to have been driven by a jump in underlying inflation. Structural reforms lagged behind schedule: in particular, mass privatization gathered momentum only slowly. 6. Nevertheless, some adjustment had occurred: for the whole of 1995, the consolidated state budget cash deficit is estimated to have reached 5.25 percent of GDP (revised classification), about 0.75 percent of GDP higher than targeted, and the deficit on a commitments basis is estimated at between 7 to 9.5 percent of GDP -- still a substantial reduction from the previous year of 9.3 percent of GDP and about 15 percent of GDP, respectively. And the Government renewed its commitment to stabilization, privatization and liberalization, despite a difficult social and political situation -- including strikes by coal miners and teachers, pressures from the agrarian lobby, and the continuous opposition of Parliament. Corrective measures were taken in early 1996 to stabilize the situation: the Government settled its external payment arrears to Russia; monetary policy was tightened; communal service tariffs, rents, public transportation fares, and energy prices to households were raised to cover 60 percent of costs including taxes. Concomitantly, President Kuchma reiterated his commitment to privatization and steps were taken to expedite the process, and substantial progress was made in removing the main remaining export restrictions. 7. This paved the way to reaching agreement with the IMF on a new program for 1996. A Standby Arrangement for US$900 million equivalent was approved on May 10, 1996. Under the new program fiscal policy will be tightened to limit the cash deficit to 3.5 percent of GDP in 1996; monetary policy will also be brought under tighter control with the aim of reducing inflation to monthly rates of 1-2 percent by the end of 1996 and to increase gross international reserves by about US$600 million. And there will be monthly targets and bi-monthly reviews to better monitor the program. Government's Economic Reform Priorities 8. Although the initial results of the stabilization efforts are positive, the reform process is clearly far from complete. There are two immediate priorities: (a) Consolidating the stabilization process. Large deficits and soaring inflation do not provide a supportive environment for investment, employment creation and growth. The tightening of credit and fiscal policies under the stabilization program has paid off in terms of reduced inflation but such policies need to be further tightened and sustained. The Government will have to resist political pressures for an increase in subsidies to industry, mining and agriculture. 2  (b) Restoring growth. A major concern is the weak performance of the real economy. After declining by 23 percent in 1994, real GDP is estimated to have declined by an additional 12 percent in 1995. This reflects the continued contraction of the state sector: according to the Ministry of Statistics, overall industrial production dropped by 17 percent in 1995. Although there are signs of a fast-growing private sector, visible in buoyant informal sector activity and in the growth of exports to non-FSU countries, this sector is not yet large enough to pull the whole economy forward. 9. Experience from Central and Eastern Europe suggests that one year into the reform process is too soon to expect a resumption of growth. In almost every transition country, the first two years have been years of fiscal consolidation and deepening of structural reforms, usually accompanied by the initiation of privatization drives. Since recovery usually comes from the private sector and from the expansion of exports, Ukraine's immediate need is the creation of an environment that fosters the rapid growth of its private enterprise sector and enhances its ability to export goods. Effective budget constraints on state-owned enterprises also would improve growth prospects. Therefore, the resumption of economic growth in Ukraine will depend on successful stabilization and an acceleration of structural reforms aimed at promoting and sustaining both a dynamic private sector and improved living standards. 10. For the next few years, the reform agenda will be dominated by four key elements: the need to promote efficient private sector activity, the need to restructure the public sector recasting it in a supportive role, the need to ensure the social sustainability of the transition, and the need to ensure environmental sustainability. Enterprise Sector in Transition 11. Statistics on the size of the enterprise sector in Ukraine are unreliable and there is no comprehensive source of information. The number of medium and large-scale enterprises, state owned at the time of independence,' is estimated by the most reliable sources at around 18,000. The number of small-scale objects is estimated by the State Property Fund at around 45,000, of which 8,000 were already privatized up to the end of 1994. However as privatization proceeds and objects are broken up at the time of privatization the total number of small scale enterprises could potentially be 50 percent higher than this. The new private sector and the informal sector also account for a growing proportion of the economy. Some estimates put informal activity at 50 percent of GDP or greater. Much of this is undeclared activity by state enterprises or by private individuals using state enterprise assets. 12. The structural problems of the Ukrainian industrial and other sectors were inherited from the former Soviet central planning system. Ukraine inherited a concentration of industrial production in very large enterprises, sometimes up to ten times the size of their western equivalents, highly 'Medium and large scale enterprises are defined generally as those having a book value as of August 1, 1993, of kbv 700 million or greater or as having special monopolistic characteristics or earmarked for special terms of privatization such as by foreign investment or military conversion. For a more precise definition of enterprise groups, see the footnote 1 to Annex 5. 3  monopolized and vertically integrated, closely linked with industry throughout the Soviet Union, and designed and located in an era when transport and energy costs were negligible and when production was geared to the needs of the military. The largest industrial enterprises in Ukraine are in metallurgy, engineering and fuel and energy processing. 13. Before the break-up of the Soviet Union in 1991 most of the medium and large enterprises in Ukraine reported directly to all-union ministries in Moscow. Procurement, marketing, product mix and financing decisions were largely outside the hands of the enterprise managers. Although privatization is now well underway, the majority of these enterprises are still in state hands and now report in theory to ministries in Kiev. But the spontaneous privatization that started gathering momentum following the Gorbachev reforms in the late 1980s, has continued. Most of the medium and large State Owned Enterprises (SOEs) in Ukraine have, in practice, been in a state of limbo for several years with unclear accountability. Even more acutely than in neighboring Russia, Ukraine's weak central administration has had little chance of imposing even a minimal governance regime over the enterprise sector it inherited. In Russia, this limitation was recognized early and mass privatization was implemented rapidly, transforming and clarifying the ownership structure of the enterprise sector and paving the way for the post-privatization restructuring that is now taking place. But in Ukraine, only during 1995 did privatization start seriously after two to three years' delay and several false starts. 14. The new ownership structure of the state enterprises that Ukraine inherited at independence is now a somewhat ill-defined mixture consisting of state enterprises in their original form, enterprises that have been corporatized but are still 100 percent owned by government or partially privatized, enterprises owned by the state but leased to the working collectives, partially bought out leased enterprises, fully bought out leased enterprises, enterprises privatized by competitive means, and other forms of mixed property. The enterprise managers have established de facto control in almost all cases, often exercising it in the name of the workers' collectives. Except for those enterprises transparently privatized as open joint stock companies, the governance of these enterprises is vague. There is widespread lack of clarity in property rights and accountability. 15. The Kuchma government's economic reform program that started in late 1994 has already done much to free up and develop private sector activity and if maintained and deepened should eventually bring the informal sector into the mainstream. However the existence of large numbers of state enterprises operating in an ownership and governance vacuum is still a major impediment to this. This situation will continue until privatization is well advanced and clear property rights are assigned to the new private owners. Until then, the tying up of assets, preferential treatment for SOE managers and pressures for inflationary budgetary support to SOEs, all crowding out the private sector, will continue. The market will not be allowed to promote restructuring and scarce managerial skills will continue to be put to inefficient use within state enterprises themselves and also within government, trying in vain to manage them. Rapid implementation of mass privatization and of measures to facilitate post-privatization enterprise restructuring are therefore critical for the short term structural transformation and the longer term economic development of Ukraine. 4  Enterprise Development Adjustment Loan in the Bank's Assistance Strategy 16. An important aim in the Bank's Country Assistance Strategy for Ukraine, which is being discussed by the Board along with this loan, is to support the expansion of the private sector as the main producer of goods and services in industry, commerce and agriculture. This support will focus on promoting an enabling environment, and on supporting rapid privatization. The policy reforms needed to achieve these aims would be supported by two complementary Bank adjustment operations intended to deliver balance of payments support in return for economy wide policy reforms, and taking over from the encouraging start made under the first stage of the reform process supported by the Rehabilitation Loan. The Enterprise Development Adjustment Loan (EDAL) would be one of these two operations. The other one would be the Agricultural Sector Adjustment Loan (AGSECAL) which would aim at developing agriculture as a source of growth through land reform and promoting competition in agricultural marketing and distribution. 17. The EDAL has been designed to complement the AGSECAL by focusing on the highest economy wide enterprise reform priorities, i.e. deepening and accelerating the privatization and post- privatization restructuring processes for enterprises throughout Ukraine, maintaining a competitive trade and price environment within which all enterprises operate, and promoting the rapid development of capital markets. The EDAL builds on the trade and price liberalization measures and enterprise reforms successfully initiated in early 1995 when, supported by the Bank's Rehabilitation Loan, Government took important steps to liberalize domestic and export prices and trade, simplified the legal framework for mass privatization and initiated the mass privatization process itself. The EDAL will support, through policy conditionality, the full implementation and extension of these pro- competition and ownership reforms and will also move to the next critical stages. Within a competitive trade and price environment the mass privatization program will be fine tuned and implemented to include thousands of enterprises according to an agreed timetable. By third tranche release, anticipated for early 1997, over half of the Ukrainian industrial workforce will be working in newly privatized enterprises. Steps are also being taken to realize the improvements in corporate governance and restructuring that are the real promise of mass privatization and of which the mass privatization process is only the first step. To this end the design of the EDAL has drawn on the important lesson learned from the Russian and Central and Eastern European experiences, i.e. that there is a need to move quickly with mass privatization, and concurrently with the development of capital markets legislation, institutions and infrastructure. This will ensure that the millions of new shareholders of privatized enterprises can trade their shares effectively, transparently and securely, thereby allowing efficient further ownership change in the secondary markets and also paving the way for inflows of new equity capital from local and foreign investors. 18. The trade, price and privatization conditionality of the EDAL is the implementation and extension of the reforms planned and initiated under the Rehabilitation Loan. The capital markets development conditionality builds directly on the recommendations of the Bank's recently completed Financial Sector Review (Report No. 14526-UA). II. MAINTAINING A COMPETITIVE ENVIRONMENT 19. For the emerging private sector to contribute to economic recovery, a strong enabling environment is required. This demands that prices reflect the true relative scarcities of goods and 5  factors, and that firms be given the right incentives both to produce what the market demands and to invest. Through such early measures as trade liberalization and the deregulation of most prices, Ukraine's reform program has limited the direct role of the state in the economy. But competitive pressures need to be increased further. External Trade and Tariffs 20. The external trade regime is crucial to growth and competition in the economy, and much has been accomplished in this area since the October 1994 reforms were launched. Ukraine has unified the exchange rate and established convertibility for most current account transactions. It has also adopted key parts of a liberal trade regime by eliminating all import and export quotas, including most recently grain export quotas, and licenses (except import licenses for some pharmaceutical and chemical products for health and safety reasons). Yet in early 1996 obstacles still remained to an open trade regime. 21. Export Regime. Remaining restrictive practices on the export side include the Special Export Regime, registration of export contracts and the use of minimum export prices, and recently introduced export duties. The Special Export Regime, which requires authorization of exporters for coal, oil, gas, spirits, and non-ferrous metal scrap, covered 6 percent of Ukraine's exports in 1995. In April 1995, in the context of its trade liberalization measures, the Government submitted a proposal to Parliament to eliminate this regulation. In addition, in 1995 export contract registration was generally removed, with the exception of three categories of goods: (i) goods covered by the Special Export Regime; (ii) anti-dumping sensitive goods; and (iii) international contingent agreements and voluntary export restraints (VERs). Prior to second tranche release: (a) the Special Export Regime will be rescinded; and (b) registration requirements will be eliminated for all exports except those under VERs and international contingent agreements and actual anti-dumping investigations. 22. More importantly, about one-half of Ukraine's exports remained subject to minimum prices, published and updated monthly by the Ministry of Foreign Economic Relations and Trade (MFERT). Though called indicative prices meant to inform exporters, they were applied as mandatory minimum prices by customs officials. Exemptions could be granted by MFERT. A decree dated September 25, 1995 removed this discretionary power from MFERT. But no statement that the published prices were not mandatory had been issued until very recently, and in effect, Customs continued to apply them as mandatory minimum export prices. In February 1996, a Presidential decree was issued limiting the minimum export prices to certain categories which, however, are still quite broad. A list of 14 narrowly defined categories of exports subject to indicative prices was published on May 8, 1996. Besides goods subject to anti-dumping cases against Ukraine, VERs and international contingent agreements, this list includes livestock, skins (see para 23) and ferrous metal scrap. Prior to second tranche release the application of indicative prices will be limited to only those exports subject to international contingent agreements, VERs and anti-dumping investigations. 23. On May 8, 1996 Parliament passed a law which introduced prohibitively high export duties on live animals and skins. In addition, the law discriminates against intermediaries by granting duty exemptions to agricultural producers who export their own goods and subjecting them only to indicative prices. To alleviate the adverse consequences of this law, the Government intends to introduce measures such as maintaining low indicative prices and ensuring broad access of agricultural 6  producers, including private farmers, to export markets for these products. Prior to second tranche release, all export duties will be eliminated. 24. Import Regime. There are no quantitative restrictions on imports other than licensing of certain pharmaceutical and chemical products for health and environmental protection purposes. Import duties are relatively low. The trade-weighted average import tariff in 1995 was 5.8%. The maximum import duty is 30% with only a few exceptions. The share of imports for which import duties were higher than 30% was 0.03% in 1995. In January 1996, however, responding to pressure from agricultural producers, the Government introduced amendments to the import duty levels for agriculture and food products, resulting in a net overall slight increase in import duties for these commodities. Furthermore, for goods requiring certification of quality and of compliance with Ukrainian standards, importers experience difficulties in obtaining certificates. Prior to second tranche release, the Government will ensure equal treatment of imported and domestically produced goods with respect to the same standards. Specifically, the Government will abolish the requirement for certification at the import level and will, instead, institute random checks of affected goods at the wholesale or retail level irrespective of their origin. This will also be important in view of Ukraine's accession to GATT/WTO. In addition, to maintain an effective competitive environment existing import restrictions will not be increased. No quantitative restrictions or non-tariff barriers will be introduced and the maximum tariff will be kept at or below 30 percent. 25. Barter Trade. Recent statistics suggest that barter is diminishing in importance. According to information from the Ministry of Statistics, barter transactions accounted for less than 34 percent of total trade in 1995 (down from 40 percent in 1994). In December 1995, a Presidential decree which provided for compulsory import deposits for barter transactions was repealed. Government has confirmed that no new implicit or explicit taxes against barter, or other such discriminating measures against exports have been or will be introduced. Domestic Trade and Prices 26. On the domestic front, the Government has gone far in the liberalization of prices and services that remained under an administered system up to late 1994. Adjustments in energy prices to world-equivalent levels a several-fold increase in prices to non-household users. Reductions in general subsidies to households, and increases in housing rents, energy and transportation tariffs, and fees for communal services have also been phased in. Cost recovery on housing and communal services is now 60 percent and is to be raised to 80 percent by July 1996. The Ministry of Economy (MOE) has also reduced the list of broadly defined categories of goods of "artificial monopolies" for which price changes have to be declared and approved in advance from 16 to 9 categories. These price controls have been additional to those regulating the prices of natural monopolies and public utilities. To ensure a true competitive environment, it will be necessary to eliminate all remaining controls on prices and profit margins. Specifically, prior to second tranche release, all forms of price controls and profit margins on "artificial monopolies" will be discontinued, and the functions of the Price Inspection Units charged with enforcing them will be accordingly limited to monitoring a small number of publicly-produced goods and services. 27. In order to bolster market competition based on correct price signals, the Government also removed distortions in domestic trade. State purchases are now confined to the needs of budgetary 7  organizations. They are based on competitively established contractual obligations. The majority of ceilings on trade mark-ups as well as profit margin restrictions also have been eliminated. The remaining restrictions on profit and trade margins in the grain and bread products were removed in May 1996. Further strengthening of the competitive environment will continue in 1997 and beyond. III. GOVERNMENT'S PRIVATIZATION PROGRAM Mass Privatization of Medium and Large Enterprises 28. Strategy since Early 1995. The procedures for mass privatization were radically streamlined by President's Decree No. 699 of November, 1994 (see Annex 5 for details of this decree and the developments that led up to it). Almost immediately after the passage of this Decree, the State Property Fund launched a privatization publicity campaign advertising the new Program and privatization certificates were made available in the first five pilot oblasts where auction centers were also set up. The first 56 enterprises were offered for sale at the end of January 1995. In February 1995 privatization certificates were made available in all oblasts and by April 15, 1995 an auction center had been opened in every oblast capital except Crimea. By the end of 1995 a national network of over 1,000 bid-collection sites had been created. The Government's goal was to initiate an irreversible program which involved the participation of the population. 29. In the first year of the Program, 1,338 packets of shares in medium-scale and large enterprises were offered for sale through monthly auctions (month-long periods in which bids could be submitted). Taking into account additional shares sold through closed subscription and other methods the total number of medium and large enterprises transferred to majority private hands during 1995 amounted to around 1,445 (or 1,015 taking the Project criterion of 70 percent transfer to private hands). While this, in the course of less than a year, was an unprecedented accomplishment, progress was far behind targets and numerous complications and areas for improvement in the privatization process still remained to be resolved. Progress was still very slow up to the end of 1995 in implementing the improved procedures required by Decree No. 699 and the pipeline of enterprises for the auction system started to run down. The Government has since, however, made good progress on resolving these issues. As of May 31, 1996, over 1,800 enterprises have been transferred 70 percent to private hands since January 1, 1995. Transfer of shares through closed subscription, privatization certificate auctions and other methods is continuing. Furthermore an additional 242 enterprises are currently in automatic clearing auctions for compensation certificates which will be completed by mid-June. By the end of June, 1996, therefore, the number of medium/large enterprises that will have met the criterion of 70 percent transfer to private hands since January 1, 1995 will substantially exceed 2,000, and of these around 35 percent will be agro-industrial enterprises. 30. Enterprise Pipeline (medium and large scale enterprises). Decree No. 699 mandated that a list of 8,000 enterprises to be privatized through certificate auctions be approved by the Cabinet of Ministers by December 25, 1994. By mid-May, 1995 a list of only 5,300 had been approved. The delay was in part due to poor record-keeping on the part of the Ministry of Statistics, but also because some branch ministries and other opponents of reform were trying to block enterprises from appearing on the list. Through a concerted effort, the State Property Fund (SPF) completed a list of 2,700 additional enterprises and it was approved by the Cabinet of Ministers in August 1995. 8  31. In order to ensure a constant supply of enterprises for auction, the SPF systemized enterprise corporatization and closed subscription procedures. This was accomplished through creation of standard, self-explanatory enterprise preparation packages which provided step-by-step instructions for completing the share allocation plan, registering the new open joint-stock company, and carrying out the closed sale of shares to workers and other privileged parties. These packages were disseminated to all enterprises still to be corporatized. The share allocation plans of those enterprises already corporatized were amended to ensure that all shares not sold during closed subscription would be offered for privatization and savings indexation certificates. 32. A Law, approved by Parliament in October, 1995, required agro-industrial enterprises to be privatized according to complicated, protracted procedures, including a 12-month closed subscription period. In addition this Law effectively guaranteed 51 percent of the shares of agro-industrial enterprises free of charge to agricultural suppliers, including state and collective farms. The Law included other damaging features, including retroactivity, that would put it in conflict with other privatization legislation. Agro-industrial enterprises account for almost half of the 8,000 enterprises scheduled for mass privatization and under the new Law would not be able to be included in the certificate auctions. To overcome the damaging effects of the Law a Presidential veto was issued in December, 1995. The Parliament produced a revised version of the Law that was little different from the first and a second Presidential veto was issued in February, 1996. Yet a third version of the same Law was approved by Parliament in May, 1996 and vetoed for the third time by the President on May 20. Meanwhile a February, 1996 Presidential decree on Privatization in 1996 established a favorable environment for agro-industrial privatization by establishing mandatory privatization targets for 1996 for all oblasts including those with high percentages of agro-industrial enterprises. The Chairman of SPF gave instructions to Regional State Property Fund directors in March, 1996 to accelerate agro-industrial enterprise privatization within their oblasts in line with the targets in the February decree. Then in May, 1996 President Kuchma gave instructions to the Cabinet of Ministers to prepare a package of normative documents that would formally streamline the agro-industrial privatization process. These procedures are expected to be formally enacted during the second half of 1996. 33. Another reason for slow development of the pipeline of enterprises for mass privatization was the lack of incentives for enterprise managers and workers to go through the process. This was particularly a problem for larger enterprises where the closed subscription process that precedes the certificate auctions did not allow them to obtain a large enough percentage of the shares of the enterprise. This was rectified by the State Property Fund in January, 1996 when they introduced a standard methodology allowing those managers who cooperate with the privatization process and deadlines the option of obtaining an additional 5 percent interest in their enterprise on preferential terms, bringing the managers' total preferential access to 10 percent in addition to the preferential access given to all employees during the closed subscription. This additional 5 percent preferential access was also confirmed in the February Presidential decree on Privatization in 1996. 34. Certificate Distribution. The pick-up rate at Savings Bank branches of paper privatization certificates was relatively slow during the first few months' of their availability. To rectify this, the SPF refocused its advertising campaign to spur citizens to collect their certificates. By the end of May, 1996, over two thirds of the Ukrainian population had either collected their paper privatization certificates or opened privatization accounts under the old methodology through the Savings Bank. 9  Also deadlines were issued in January, 1996 for the population to collect their privatization certificates by June 30, 1996 and to use them in the auctions by December 31, 1996. Distribution of savings indexation certificates to Savings Bank branches began in August 1995 and to the population in February, 1996. 35. Public Information. Because opponents of privatization have often attempted to block it on the grounds of procedural violations, as was the case with the moratorium imposed by the Parliament in July 1994, the SPF initiated an effort to further increase the transparency and fairness of the privatization process. To this end, the SPF began to publish clearer information on enterprises when announcing the sale of their shares at certificate auction including the full share allocation structure for the enterprise and what amount was sold during closed subscription. Likewise, during the first three months of 1996 the SPF created an information management system and mandated that auction results be published within three weeks of the closing of the auction. 36. Operation of Auctions. Demand during the first certificate auctions was relatively low. Of the enterprises offered for sale, at least 70 percent were left with unsold packets of shares, which needed to be re-auctioned. This was due to a range of factors, which the Government has since addressed. First, the public was still unaccustomed to and somewhat skeptical about the use of paper certificates and the new auction procedures. To overcome this, the SPF launched a public relations campaign specifically addressing the public's remaining confusion and doubts. A second reason for initial low public participation in auctions was the lack of a bidding center network in the regions. While auction centers had been created in every oblast capital, about two-thirds of the population live outside these areas. First attempts to conclude contracts with private entities as well as the Savings Bank and the Post Office to act as bid reception sites were not successful. But since then, through an aggressive campaign to attract private sector participants, the Ukrainian Auction Center has successfully created a network of more than 1,000 bidding centers. Since late 1995, the percentage of shares sold has started to increase. 37. Probably the most important reason for the undersubscription of the first auctions was the prohibition on the sale of shares below nominal price. This prohibition was initially based on interpretation of law, though the underlying reasons for the SPF's adherence to this policy were fears of accusations of selling enterprises too cheaply and that large parts of a single enterprise might be transferred to one party. However, the results of the first auctions showed that many enterprises were simply far less attractive to investors than others and that a share's nominal price was in many cases not an accurate reflection of its market value. The operational problem that followed from this was the need for many repeat auctions. The SPF realized that it was attempting to sell shares on a non- economic basis and that it would need to expend significantly more resources to carry out repeat auctions and attempt to distribute the remaining shares. Starting from January, 1996, after the completion of the bidding center network ensured access for all citizens to participate in auctions, the SPF stopped holding repeat auctions for privatization certificates. The Cabinet of Ministers approved procedures for the use of savings indexation certificates in February, 1996. Since May 1996 the SPF has allowed the complete clearing of auctions for shares sold for index-linked savings certificates without any restriction on the selling price. 10  Small-Scale Privatization 38. Progress with small-scale privatization during the first part of 1995 was slow. The first hindrance was a delay in the passage of implementing procedures by the SPF and the Cabinet of Ministers. The full set of documents required under the enabling 1994 Decree was not approved until March 1995. A second problem was that local authorities in many areas did not cooperate with the provision in the Decree which mandated that they compile and submit lists of all small-scale enterprises available for privatization. Third, the sale of premises was not as effective an incentive as it was hoped, since the valuation methodology which takes into account potential profitability set purchase prices prohibitively high. Finally, the June 1, 1995 deadline for the exercise of lease-with-buyout did not produce the expected number of buyouts, and had to be extended. 39. The main factor which makes small scale privatization less amenable to policy actions by the central government is that the process is controlled largely at the local level. It is therefore strongly dependent on the degree of commitment of local politicians and officials. In Ukraine, as in Russia and other countries of the former Soviet Union, this commitment varies greatly from one locality to another. The results are the large variations between different cities and oblasts in the speed of small-scale privatization despite strong commitment by the national government and the existence of a uniform and relatively favorable national policy framework. 40. The SPF has, however, given high priority to addressing the obstacles within its control. Because of the delay in the approval of implementing procedures, a President's Decree was signed in June 1995 amending the December 1994 Decree on Small-Scale Privatization and extending the deadline for workers' collectives of leased enterprises to apply to buy-out until September 1, 1995. The SPF also issued orders to all local privatization bodies that as of December, 1995 no leases on small enterprises should be renewed after their expiration. In addition, the SPF started taking disciplinary action against local officials who did not comply with instructions to implement small-scale privatization. Other measures taken were increases in lease payments and reductions in asset valuations, both of which made the buy-out of small-scale enterprises by leaseholders a more attractive option. 41. As a result of the above measures and the growing impact of the hard budget constraint on local authorities, implementation of the small-scale privatization program accelerated rapidly during the second half of 1995. Among the donors, IFC was particularly active in supporting small scale privatization. As of May, 1996 over 65 percent of formerly state controlled small enterprises are in private hands and around 1,500 small enterprises per month are undergoing privatization. Barriers to entry for small-scale entrepreneurs have been progressively removed over the last two years and surveys show that access to real estate, once a major barrier, is no longer perceived by entrepreneurs as an obstacle to starting and running a business. Early in 1994, responsibility for small-scale privatization was transferred from the many individual privatization bodies to the SPF. The November, 1994 Presidential Decree on Small-Scale Privatization strengthened the mandate of the SPF to complete the task. Although the authority of the SPF was eroded during 1995 and then again in May, 1996 by the passage of a Small Scale Privatization Law by Parliament, which transferred some of its responsibilities back to local authorities, the mandate of the SPF to complete small scale privatization during 1996 was affirmed by President Kuchma in a widely publicized pronouncement in January, 1996 and the SPF continues to benefit from Presidential support. The Government's aim is now to complete small scale privatization throughout Ukraine by the end of 1996. 11  IV. GOVERNMENT'S CAPITAL MARKETS DEVELOPMENT PROGRAM 42. The Government recognizes the need to create well regulated and efficient capital markets as a direct extension of the mass privatization program in particular, and as a transition to a market economy in general. Protection of unsophisticated investors on the one hand and improvement of corporate governance and strengthening of growth opportunities of privatized companies on the other are the main objectives of the program. To achieve these objectives, the Government took a number of measures during the latter part of 1995 and early in 1996. Creation of an Independent State Supervisory Body 43. A Securities and Stock Markets Commission (SSMC) was created in June, 1995 by Presidential Decree. The Commission is responsible for the implementation of government policy with regard to functioning of the securities markets and coordination of the activities of state executive bodies in this area. A Chairman, Deputy Chairman and three Commissioners were appointed. They are independent full-time officials appointed for a fixed term and removable only under very strict conditions provided by the Decree. The SSMC has two purposes: (i) to promote and ensure professional, fair, orderly and transparent operation of the capital markets, and (ii) to promote and protect investors' rights. The SSMC will regulate, license and supervise the following activities and services of market participants: (1) initial public offerings of securities, (2) operations of registrars, depositories, custodians, (3) broker/dealer, investment advice and portfolio management (4) secondary trading systems, (5) clearing and settlement, (6) offering and management of collective investment vehicles, (7) investment banking services (underwriting, public placement, etc.). The Commission has been staffed with specialists and furnished with the office space and equipment necessary for its proper functioning. The Commission received a temporary budget to hire 82 staff members. Financial resources were allocated from available grants to hire two long-term consultants in the areas of securities legislation and operational procedures. The organizational units of the SSMC - legal, licensing, supervision, corporate finance (securities) - had begun operations by late 1995. 44. A good start has already been made in transferring responsibility to the SSMC of capital markets supervisory functions previously exercised by other bodies. A Presidential decree of November 18, 1995 transferred responsibility to the SSMC for supervising investment funds and investment companies. A Presidential decree of March, 1996 transferred responsibility to the SSMC for regulating activities of registrars and depositaries. Promotion of Self-Regulatory Organizations 45. Work on the creation of self-regulatory organizations (SROs) for market participants, and plans for the delegation of supervisory functions from the SSMC to the SROs, have begun. The Government has supported an initiative sponsored by USAID to organize firms offering services in the area of collective investments into one SRO. The Government has also supported another initiative sponsored by USAID to create an SRO of broker/dealers to operate a regulated over-the-counter market. These organizations should gradually take over many of the regulatory and disciplinary functions of the SSMC regarding business conduct of their members. The intention is for the SSMC functions in this area to be reduced to supervision of the SROs and the hearing of appeals against decisions taken by the SROs' statutory boards. The SSMC will approve Codes of Conduct of the SROs 12  by end-i 996. The legal framework for the SROs should be adopted and membership of the respective SRO for all licensed market participants will become mandatory by third tranche release. Regulation 46. In September, 1995 the Parliament adopted a formal concept paper outlining the future operations and development of the stock markets in Ukraine. The Government submitted a draft Law on State Control of Securities Markets, based on the concept paper. The Law would give the SSMC full authority to regulate and supervise the markets. In the meantime, pending approval of the Law the SSMC has prepared a number of draft decrees and regulations which will empower the Commission to regulate the most important areas of functioning of capital markets: (a) Investor Protection. Measures to protect small unsophisticated investors, such as: disclosure requirements for publicly offered and traded securities, safeguards against fraud and market manipulation. (b) Registrars, Depositories, and Custodians. An independent registrar to be obligatory for all publicly traded (open) joint-stock companies; licensing, reporting, and capital requirements for commercial entities offering above services. (c) Broker/Dealers, Investment Advisors, Portfolio Managers, and their SROs. Licensing, reporting, and capital requirements for commercial entities offering the above services; the basic rights, responsibilities and supervisory functions of SROs of professional market participants. (d) Trading Systems. Standard requirements for licensed trading systems i.e. stock exchanges and over-the-counter markets; this includes concentration of trade, transparent and fair trading procedures, access for all licensed market intermediaries and membership of at least 10 licensed brokers/dealer firms, not-for-profit operations, dissemination of information, safe and efficient system of clearing and settlement of transactions (securities and payments). All of the above decrees will be enacted during the second half of 1996 and will provide a functional legal basis for securities market supervision until a new version of the Securities Law is approved by Parliament. 47. During the first part of 1996 the Government started taking practical steps to transfer to the SSMC all functions related to regulation and supervision of securities markets. The Commission is working closely with the SPF to secure a smooth transition from initial distribution of shares in privatized enterprises to secondary trading in these shares. To focus and coordinate the legislative efforts of the SSMC and different governmental agencies, an inter-governmental Committee was created. The Committee is chaired by the Deputy Prime Minister and consists of representatives of the SSCM, the Ministries of Economy, Finance and Justice, the NBU, the Anti-Monopoly Committee, and the SPF. The SSMC coordinates the work of the Committee. 13  Transitional Institutional Arrangements 48. The Government has initiated and is supporting transitional arrangements whenever private initiative is either not yet evident or exists but needs temporary assistance. (a) Share Registrars. The Government initiated amendments to existing legislation necessary for the mandatory creation of independent registrars of shares of privatized companies. Ten pilot registrars have already been established and/or strengthened with support from international donors. Additional serious candidates are already being considered. The ultimate goal is to transfer registrar functions to private operators. A regulation, setting criteria for licensing registrar/depositary services, has been adopted. While waiting for private operators to develop the capacity to deliver enough registrar services the privatization auction centers have been operating as temporary registrars. A separate unit has been created within each regional auction center, with its own staff and equipment, with the central database in Kiev. The units are subject to supervision by the SPF. (b) National Depositary System. Following the adoption in 1995 by Parliament of the general concept, the Government initiated the legislative and institutional measures necessary for creation of a National Depositary System (NDS). The NDS will cover state securities, corporate stock, and corporate bonds. The system will likely consist of a single depository for state securities and a number of privately operated depositaries for corporate securities. Integration of the system will be achieved by introducing standards for operations and information flow. An outline of the program has been extensively discussed with the donor community and the Bank. The first components of the NDS will be operational before release of the third tranche. The draft program of the ADS will be discussed with the Bank in mid-1996 and presented in a form agreeable to the Bank before November 1996. The National Depository will be ready to begin operations early in 1997. V. DONOR COORDINATION General 49. Over the past two to three years there has been a very close dialogue between the Bank and the donors supporting privatization, capital markets development and post-privatization enterprise restructuring assistance in Ukraine. This has been marked by a series of donor meetings in Washington, London and Kiev and, in February, 1994, by the signature of a joint Memorandum of Understanding by the major donors and the Government on the future direction of the mass privatization program and on the external support that could be provided for it. This close cooperation has continued during the preparation and implementation of the pre-Board action program of this loan and will continue during loan implementation. The combination of policy analysis and conditionality from the Bank and grant financed technical assistance from other donors has proven to be extremely effective in the Ukrainian context. The Program supported by this loan has therefore been designed in full cooperation with the other major donors, in particular USAID and EU/TACIS, and has their full support. The latter two donors will continue to provide most of the technical 14  assistance necessary to complete the mass privatization program, to create the necessary capital markets legislation, institutions and infrastructure and to promote the post-privatization restructuring and growth that will be the major objective and benefit of the program. The close dialogue that already exists with the IFC will also be maintained and IFC intends to continue its support for privatization implementation throughout 1996. EU/TACIS 50. The conditions for disbursement of the EU's forthcoming ECU200 million program loan to Ukraine will be closely linked to the implementation of the policy conditionality of the EDAL. EU/TACIS has been actively supporting the privatization process in Ukraine since independence. Early support was for the SPF and for pilot privatization transactions. Since 1994 the programs have focussed more on mass privatization and more recently on the development of the capital markets. At present EU/TACIS consultants are helping with the implementation of the MPP auction process in several oblasts and also with the institutional strengthening of new investment funds. EU/TACIS have also been instrumental in creating the capacity of the Ukrainian Center for Post-Privatization Support (UCPPS) The Bank has coordinated particularly closely with EU/TACIS on the design of the EDAL's post-privatization support component. As mass privatization proceeds more EU/TACIS operational support is planned for the SPF and particularly for the post-privatization assistance programs to be implemented by the UCPPS. Assistance will also be given to case by case privatization of large enterprises. Work is also being done by EU/TACIS on the methodology for divestment of social assets by enterprises. USAID 51. USAID continues to finance major costs associated with the mass privatization program, including printing and distribution of the privatization certificates, the operational costs of the enterprise auction centers and the public information campaign for privatization in the national and local media. USAID has also been the major source of finance for IFC's support to the small scale privatization process in several cities throughout Ukraine. Other USAID initiatives already underway or soon to be started include support for the development of selected private investment funds and for the creation of a new self-regulatory organization for market intermediaries, creation and running of a capital markets monitoring unit, support for US SEC staff from Washington to advise the Government on creating new capital markets legislation and supervisory bodies and support for creating a share registry and a clearing and settlement organization. Other Donors 52. The Bank and many donors, including EU/TACIS and USAID have provided city and enterprise level support for privatization and private sector development programs. IFC has been particularly active in promoting small scale enterprise privatization at city level and also some large scale pilot privatization transactions. The EBRD was active early in supporting the SPF and is now considering replicating in Ukraine the Regional Venture Fund concept that been a vehicle for direct EBRD equity investments in newly privatized enterprises in several Russian cities. Bi-lateral donors such as Switzerland, Netherlands, UK Know-How Fund and Japan are also actively supporting the 15  privatization process in Ukraine. A Japanese technical assistance grant and a grant from the Irish Government, both managed by the Bank, have helped in the preparation of the EDAL. VI. THE PROPOSED LOAN Background and Rationale for Bank Involvement 53. This project is consistent with the Bank's Country Assistance Strategy for Ukraine (CAS) which is being presented for discussion along with this loan to the Executive Directors. The proposed loan will provide a significant portion of the external balance of payments support necessary to maintain the Ukrainian economy during the economic transition period while at the same time supporting through policy conditionality reforms critical to the success of this transition. It will continue the balance of payments support initiated by the IMF in its Standby Arrangement and Systemic Transformation Facility and the Bank through its Rehabilitation Loan and disburse in parallel with funds from the Bank's proposed Agricultural Sector Adjustment Loan. The loan design has built on the successful formula, already demonstrated in the Ukrainian context, of focussed Bank financed policy conditionality working alongside grant financed technical assistance from other donors. Loan Objectives and Description 54. The main objectives of the proposed EDAL will be to support the Government's trade and price liberalization, privatization, capital markets development and post-privatization restructuring programs as outlined in the Memorandum of Enterprise Sector Development Policy (Annex 1). It is intended, through policy conditionality and technical assistance, to promote and make irreversible the economic transformation of the enterprise sector from a primarily state owned to a primarily private ownership structure, to realize the necessary enterprise governance improvements and accelerate the restructuring and enhance the efficiency of the enterprise sector following privatization. It will therefore complement the agricultural sector reforms supported by the AGSECAL. 55. Given the urgent need for balance of payments support most of the policy based balance of payments support component of the loan is expected to disburse quickly and the completion date of this component will therefore be December 31, 1997. The technical assistance component is also intended to disburse quickly given the urgent need for immediate post-privatization enterprise restructuring assistance and the completion date for this component will therefore be December 31, 1998. The proceeds of the balance of payments support component of the loan will be disbursed upon evidence that the agreed adjustment measures have been satisfactorily implemented. Non- eligible imports would comprise only those goods on the World Bank's standard negative list. As agreed with the Government, disbursements will be made through the NBU and an account of the Ministry of Finance at the NBU will be credited with the karbovanets equivalent at the market exchange rate as determined on the interbank exchange market. The foreign exchange receipts of the loan will be sold by the NBU in the interbank exchange market or will be held in reserve in accordance with the objectives of monetary policy. The Government will therefore receive non- inflationary budget support. The technical assistance component will be disbursed according to the standard procurement and disbursement rules of the World Bank. 16  56. The components of the loan will be: (a) Balance of Payments Support for Policy Reforms ($300 million). The policy reforms will include: (i) eliminating trade barriers and price restrictions on imports and exports; (ii) eliminating domestic price controls; (iii) implementation of mass privatization of 5,000 medium and large scale enterprises; (iv) completion of the small scale privatization program; (v) resolution of several important methodological obstacles to rapid implementation of the privatization program; (vi) extension of the privatization program to include additional large enterprises for case- by-case privatization; (vii) creation of a Securities and Stock Markets Commission to oversee and regulate capital markets; (viii) creation of self-regulatory organizations for intermediaries in the capital markets; (ix) legislation will be in effect governing the operations of: a. stock exchanges and over-the-counter markets; b. dealers and brokers; c. independent registrars and depositories; d. self-regulatory organizations of market participants; and e. rules governing investor protection such as disclosure requirements for publicly traded companies, fraud and market manipulation. (b) Technical Assistance for Post-Privatization Restructuring ($10 million). This component will finance necessary technical assistance and equipment to the agencies responsible for implementing the post privatization restructuring programs. The component will include turnaround management assistance in the form of consulting advice on restructuring for post- privatized enterprises, bankruptcy and liquidation pilots, development of professional organizations and management training 17  Project Implementation and Key Measures for Disbursement 57. Implementation of the policy reforms began during loan preparation in mid-1995 and continued during the first half of 1996. The first tranche will be disbursed based on satisfactory implementation of the pre-Board action program described below. The TA component is expected to begin in mid-1996. The SPF will be the main implementing agency for the policy reforms but other agencies will also be involved in implementation of the reform program including the Securities and Stock Markets Commission. 58. The following measures were implemented prior to Board presentation of the proposed loan (these measures constitute the pre-Board action program and conditionality): (a) Maintaining a Competitive Environment (i) imposition of minimum prices for exports was abolished except for fourteen narrowly defined categories of goods limited to specific actual cases of anti-dumping, products subject to contingent intergovernmental agreements, live animals, skins and non-ferrous metal scrap (ii) a maximum import tariff of 30 percent was maintained (iii) compulsory import deposits for barter transactions were abolished and no new taxes on barter imposed (b) Mass Privatization of Medium and Large Enterprises (i) the SPF substantially completed the privatization of 2,000 medium/large enterprises (i.e. transfer of at least 70 percent of the enterprise shares to private hands) since the beginning of 1995. Of these enterprises over 30 percent were on the original list of agro-industrial enterprises (ii) streamlined procedures and standard preparation packages were developed and disseminated to enterprises subject to mass privatization (iii) a network of over 1,000 bid collection sites was developed for the certificate auctions (iv) steps were taken to begin streamlining the procedures for the privatization of agro- industrial enterprises, shortening the subscription processes and reducing the total preparation and processing time to a level comparable to that for enterprises in other sectors (v) an incentive mechanism to allow managers who cooperate in privatization to obtain 10 percent of the shares of enterprises in the mass privatization program on preferential terms was implemented 18  (vi) procedures were developed for the redemption of index-linked savings certificates in clearing auctions with no floor prices and implementation of these auctions began (vii) deadlines were set for the collection (June 30, 1996) and redemption (December 31, 1996) of privatization certificates (c) Privatization of Small-Scale Enterprises (i) Amendments were made to the Methodology of Valuation of Objects for Privatization revoking the use of potential profitability as a factor in the valuation process (ii) there was no reversal of the favorable legal, institutional and methodological framework which led to the rapid acceleration of small scale privatization during the second half of 1995 and early 1996 and small scale privatization continued at a rapid pace (d) Capital Markets (i) the Government created an independent SSMC, with responsibility for overseeing and regulating capital markets in Ukraine, and staffed its key departments of legal, licensing, supervision and corporate finance. (ii) a package of draft legislation was prepared governing investor protection, registrars and depositaries, broker dealers, trading systems and self-regulatory organizations (iii) a transitional data-base of shareholders of companies privatized through open auctions (transitional share registries) was created at the Ukrainian Center for Certificate Auctions (e) Post-Privatization Restructuring Assistance (i) the SPF created a technical assistance coordinating unit to manage the technical assistance component of the program funded by the loan as well as all other technical assistance to be administered by the SPF (ii) a plan for staffing, training and equipment needs was prepared for the UCPPS and implementation began (iii) TORs and shortlists of consultants, budgets and implementation schedules were prepared and equipment costs and sources determined 19  59. The following actions will be completed prior to release of the second tranche, anticipated for November 30, 1996: (a) Maintaining a Competitive Environment (i) there will have been no reversal in the liberalized trade and price regime adopted prior to Board presentation (ii) all export duties will be eliminated (iii) indicative prices on exports will be eliminated except for goods and services covered by voluntary export restraints, anti-dumping investigations and international contingent agreements (iv) the Special Export Regime will be rescinded (v) registration requirements for exports will be abolished except for exports under voluntary export restraints, anti-dumping investigations and international contingent agreements (vi) quality certification of goods at the import stage will be replaced by a system of random checks at wholesale or retail level (vii) domestic price controls on all sixteen "artificial" monopolies will be abolished, trade and profit margin caps will be abolished (viii) regulation of prices and operations of price inspection units at state and regional levels will be limited to only those goods or services whose prices are administratively set (b) Privatization (i) the SPF will have completed the privatization 3,500 medium/large enterprises since the beginning of 1995 (i.e. the enterprises will be at least 70 percent privately owned). Of these at least 30 percent will have been on the original list of agro-industrial enterprises (ii) changes, initiated prior to Board presentation, streamlining the methodology for agro- industrial privatization, will have been formally enacted (iii) there will have been no reversal of the favorable legal, institutional and methodological framework governing small scale privatization which will have continued at the same rapid pace (c) Capital Markets (i) the transitional database of shareholders will be transferred from the auction centers to new private independent share registrars where they exist 20  (ii) the package of legislation governing the operation of the capital markets, prepared before first tranche release, will be enacted (iii) Government will prepare a time schedule for establishing a National Depositary System for Shares 60. The following measures will be implemented prior to release of the third tranche, anticipated for March 31, 1997: (a) Privatization (i) the SPF will have completed the privatization of 5,000 medium/large enterprises since the beginning of 1995. (i.e. the shares will be at least 70 percent privately owned). Of these at least 35 percent will have been on the original list of agro-industrial enterprises (ii) the Cabinet of Ministers will approve a list of 10 large monopoly enterprises and initiate work on the development of plans to privatize these enterprises before the end of 1997 (iii) there will be no reversal of the favorable legal, institutional and methodological framework governing small scale privatization which will continue at the same rapid pace (b) Capital Markets (i) self-regulatory organizations for collective investment intermediaries, broker/dealers and registrars and depositaries will adopt their rules of conduct and membership of respective SROs will be made compulsory for all licensed market participants (ii) the NDS will start operations Technical Assistance Component for Post-Privatization Enterprise Restructuring 61. The Need for Post-Privatization Enterprise Assistance. With increasing economic liberalization and implementation of privatization through the mass privatization program, one of the most relevant and valuable forms of external assistance will be technical advice and support to enterprises after privatization and to develop the institutions needed to operate a market economy. The post-privatization enterprise assistance component of the loan is an integral part of the support for the mass privatization process, and its introduction, just as privatization is gaining momentum, is timely. 62. Type of Assistance to be Provided to Enterprises. The total estimated cost for this component is US$10 million. Detailed terms of reference for the advisors to be financed under the component are on file. Annex 7 gives a schematic description of the component with procurement details. In complement to other donor support (primarily from USAID and EU (TACIS)) the TA component focuses on three areas. The first area is support for enterprise restructuring, where the Government will support at least 15 enterprises with operational restructuring help. The overall objectives are to develop demonstration cases, to prepare case studies for management training, to support the 21  development of local consulting services, to stimulate enterprise demand for technical assistance, to test various models for restructuring and cost recovery, to identify bottlenecks to liquidation, and also to assist a limited number of individual enterprises. There will be four different approaches to restructuring at an estimated cost of US$5.8 million. (a) Low-Cost Change Management Assistance (CMA). This effort would provide low-cost restructuring advice to enterprise managers over 1.5 to 2 years. The effort would be led by a senior consultant (e.g., a retired executive) who would be responsible for recruiting (from a pre-qualified pool) specialists for specific tasks. Deliverables would include diagnostic analysis, financial audit, management training, social and environmental reviews, study tours, short-term action plan. implementation of action plan, and provision of case study material. Participating enterprises would co-finance the cash costs and provide local accommodation. Estimated total cost - US$1.2 million for 4-5 restructuring cases. (b) TA Fund. The Government would create a fund for TA financing and recruit investment managers to operate a specialized investment agency. The managers would identify privatized enterprises interested in attracting core investors, local or international. These enterprises should need operational restructuring to be able to attract investors and should be willing to borrow for, and to use, consultants to implement restructuring. The enterprises should also be willing to pay a success fee to the managers for finding investors. Once identified and an appropriate program established, the enterprise would borrow from the TA fund, restructure under the supervision of the managers, and once an investor has been successfully identified, fully repay the TA fund and pay a fee to the managers. Alternatively, or as a complement, once a larger corps of venture capital firms has emerged, the Government could create a fund for TA financing from which venture capital firms could apply for TA financing for operational restructuring from the fund (subject to a cap of US$500,000), to be repaid in full. The venture capital firms would then implement restructuring of enterprises in which they have significant ownership subject to pre-determined deliverables including adequate reporting to the Government and provision of case study material. Estimated cost US$2.75 million for the fund and investment management group for two years and at least 10 restructuring cases. (c) Intensive Demonstration Case. A large, potentially viable, and socially important enterprise would be restructured using top quality management consultants. The consultants would deliver both case study material and a plan for how to demonstrate the potential value of restructuring to other enterprises. Estimated total cost US$900,000 plus enterprise co- payment of at least 10 percent. (d) Liquidation and Bankruptcy Pilots. Two state-owned enterprises suitable for liquidation would be taken through the process of bankruptcy liquidation by one group of consultants. Preferably, one pilot would result in an out-of-court settlement, whereas the other pilot would result in settling the liquidation through a court ruling. During the process, consultants would identify legal and other obstacles and suggest improvements, develop streamlined processes for both methods of liquidation, and provide case study material. The Agency for Bankruptcy and Liquidation would provide staff members to participate in the consulting team. The consultants would also provide for 1-2 months internship for 2 Agency staff members at similar agencies in Eastern Europe. Estimated total cost US$950,000. 22  63. The second area of support is the development of critical functions necessary in a market economy including catalyzing professional associations, establishing a commercially oriented business database on private enterprises, and developing a management training program based on Ukrainian case studies (derived from the restructuring cases above). The overall objectives are to stimulate the development and quality of various professions (e.g. corporate lawyers, accountants, management consultants), make available critical business intelligence on private companies for investors and enterprises, and stimulate the development of enterprise managers through an intensive short training program based on Ukrainian experiences. Total estimated cost for this sub-component is US$2.35 million. (a) Development of Professional Associations. The Government would provide a consultant and some operating resources for organizational development and professional seminars to each of approximately 10 existing or possibly new professional associations. The Government would finance the startup or further development of these associations, and also use the roster of members to be developed as its longlist for consulting contracts. In exchange, the association would try to recruit and register all qualified local professionals, develop professional standards, and provide unofficial certifications of professional competence. Total estimated cost is US$950,000 over 3 years. (b) Commercial Private Company Database. The ultimate objective is to establish a separate fully commercial company in joint venture with an established business intelligence company. The company would potentially be quite profitable and Government's interest should eventually be fully divested. The approach would be to develop a database initially using data from the SPF gathered during the privatization process, including contractual arrangements with SPF. In parallel, consultants would help develop a business plan, set up a skeleton company, and develop and implement an approach to attract potential joint venture partners. The joint venture partner would contribute the systems, management, and working capital to operate the company. The Government would provide both an existing database and facilities for further data generation. Total estimated cost US$450,000. (c) Management Training Based on Ukrainian Case Studies. High quality academics would be recruited to develop case study material (preferably multimedia including plant visits and sessions with enterprise management), based on the restructuring cases described above. The consultants would build a 2-3 week training curriculum around the case material, and develop and implement a plan to deliver the training to managers, preferably through an existing local training institute. Total estimated cost US$950,000. 64. The third area of support is the strengthening of Government organizations for privatization and post privatization support. This sub-component would provide a limited amount to support the SPF and the newly established Ukraine Center for Post Privatization Support (UCPPS). The SPF is responsible for implementation of mass privatization and management of this $10 million TA component, whereas UCPPS has been established by SPF with assistance from EU/TACIS as a non- profit non-government organization to support privatized enterprises. Both organizations need further assistance on internal organization and systems and there is also a need for a system of data generation and transfer to the private company database, described above. The total estimated cost for this sub-component is US$ 1.85 million. 23  (a) SPF Organizational Needs. One potential area of activity in the near future for SPF would be to finalize the privatization of the (approximately 50) most important companies, in which the Government would not follow the standard mass privatization procedures. To prepare for these case-by-case transactions, SPF would benefit from building up the required skills, processes, documentation, and contacts with investment banks to implement the transactions in a high quality manner. This sub-component would also help identify in advance regulatory needs, competition issues, potential restructuring efforts required, and other issues that may delay privatization. For this purpose, SPF would employ one or two international experts to provide this advice for 1-2 years, supported by 1-2 Ukrainian professionals to be trained to administer later the implementation of the transactions. Another area of support would be to provide advisors to the SPF. This would include the establishment of a Project Implementation Unit (PIU) for the TA component of the loan. The role of the PIU is described in more detail in the next section. These areas are also being supported both by the Bank's Institution Building Loan and by EU/TACIS, and the TA component would only provide assistance in addition to and as a complement to these efforts. The estimated total cost of the three areas of support to the SPF is US$1.2 million. (b) UCPPS Organizational Needs. The newly established organization needs equipment, key staff (e.g., lawyer, accountant, experienced procurement specialist) and staff training. It also needs internal processes and systems for selection of enterprise restructuring candidates and for procurement of consultants. UCPPS would employ consultants and strengthen its staff to help develop and arrange for training and recruitment, to identify and procure critical equipment, develop branch offices, develop internal procedures, and manage the implementation of the post-privatization components (except for support to SPF). In addition it may be necessary to ensure the transfer of data from SPF to UCPPS. The objective would be to ensure that the commercial database being created has automatic access to all relevant data on enterprises that have been processed through the mass privatization program. This will include systems, hardware, procedures and staff needs for the next two years. A consultant will be recruited to design and implement the system, linking it to SPF's databases and the database company. If not needed this amount could be reallocated to the strengthening of the UCPPS. EU/TACIS will continue to provide support to UCPPS, and the objective is to complement and to fill gaps not covered by the EU program. The cost for the data transfer sub-component is estimated at US$150,000 and for the entire component, US$ 650,000. 65. Selection of Enterprises for the Post-Privatization Assistance Component. The Government will select enterprises for this assistance. The principle will be to attract at least 10 enterprises for each restructuring effort. The enterprises would provide a simple description of the company following the criteria below. A technical selection committee would screen the longlist for the best candidates, and invite them to provide more in-depth information. Based on the additional information, the committee would establish a shortlist of the most promising candidates, after which the consultant responsible for implementing the restructuring will then suggest the final candidate, subject to Government approval. The criteria for selection would in general be (to be specified for each project): 24  (a) The Enterprise Must be Private. This is defined as non-governmental ownership of at least 70 percent of the shareholding. Enterprises demonstrably in the later stages of being processed for privatization and whose shares are projected to be in great demand could be considered, in which case the restructuring effort would include finalization of privatization. (b) Management Commitment. This is a critical criterion since without committed management supported by the shareholders, restructuring has no prospect of succeeding. It is a subjective criterion, and the final judgment will be made by the Government based on advice from the consultants. Possible indicators, however, include management's willingness to co-finance the restructuring effort, progressive actions already taken to restructure and downsize, statements of intent, and willingness to work with foreign and local consultants. (c) Potential Viability. The enterprise should have the clear possibility of developing a positive cash flow within the near future. Management should be able to put forward a simple pro forma income statement indicating its potential improvements over the next five years, with explicit assumptions. (d) Financial Liabilities and Investment Needs. If the company is heavily burdened with commercial liabilities and/or has substantial critical investment needs, such that even a successful operational restructuring would not be able to ensure viability, the company would only be considered if liquidation is acceptable to management and shareholders. Loan Administration for Investment Component (Technical Assistance) 66. Administration of the TA component will be the responsibility of a Project Implementation Unit (PIU) within the SPF. The PIU will be staffed by a local manager, an international procurement specialist, a local accountant and a local lawyer. The terms of reference of the staff of the PIU were agreed with the Bank and the PIU was established prior to Board presentation. The TA component of the EDAL will include US$200,000 to finance salaries of the members of the PIU and basic office equipment for the PIU. The training and experience received by members of the PIU in implementing this TA component is expected to facilitate the implementation of future projects financed by the Bank and other donors. In the second half of 1997 the PIU will prepare a mid-term report on progress in the TA component and this report will serve as the basis of a mid-term review to be carried out jointly with the Bank before the end of 1997. 67. The PIU will be assisted extensively by the Ukrainian Center for Post-Privatization Support (UCPPS). The UCPPS was established recently with support from EU/TACIS and is developing excellent skills in procurement and consulting services. In January 1996 staff from UCPPS attended a one week Bank procurement workshop conducted by international procurement specialists. The responsibilities of the UCPPS and the SPF regarding the implementation of the TA component will be outlined in detail in a legal agreement between both organizations and this agreement will be signed before the TA component becomes effective. A memorandum of understanding outlining the principles of this agreement has already been signed. Supervision of external consultants is likely to play an important role in developing the consulting capacity of UCPPS staff. 25  68. The UCPPS will, among other things be responsible for preparing and submitting for approval to the PIU all documents concerning the selection of consultants and equipment and requests for clearances from the Bank. The UCPPS will also maintain direct contact with the Bank and supervise consultant activities and prepare and submit to the PIU reports on consultants' activities. The PIU will be responsible for the overall implementation of the TA component. It will, among other things, report directly to the Chairman of the SPF and the Bank, approve the selections of consultants and equipment and the requests for clearances proposed by the UCPPS, submit documents for clearance to the Bank, manage the UCPPS "by exception", provide advice to UCPPS, maintain project accounts, verify payments due under project contracts and fulfill all other responsibilities outlined in the Funds Transfer Agreement between the MOF and the PIU. Loan Administration for Adjustment Component 69. Administration of the adjustment component will be the responsibility of a Monitoring Unit (MU) located in the Ministry of Economy and it will report through the Chief of the Division for Collaboration with International Financial Institutions in the Cabinet of Ministers to the Deputy Prime Minister for Economics. The terms of reference have been agreed with the Bank and the MU has been established. The MU's main responsibility will be to monitor implementation of the adjustment component and provide progress reports to the Government and the Bank every three months after Board approval. The progress reports will contain an evaluation of the progress made on the policy reform program and will indicate progress made towards fulfilling tranche release conditions. These reports will be sent to the Bank every three months in English. The MU will also prepare Ukraine's contribution to the Project Completion Report within six months of the closing date. Procurement under Investment Component (Technical Assistance) 70. Procurement will be in accordance with the World Bank Guidelines for Procurement, dated January, 1995. A Country Procurement Strategy Note is expected to be completed in FY97. 71. Procurement of Goods. The TA component will finance expenditures related to the purchase of equipment i.e. furniture, computers, software, telecommnunications and general office equipment. Only a relatively small amount (US$1 million) of the TA component will be used to purchase equipment such as office equipment for a database of privatized enterprises, for the UCPPS, for the SPF and for enhancing data transfer from SPF to UCPPS. 72. This equipment will be procured by national shopping for the contracts under US$50,000 and by international shopping for contracts between US$50,000 and US$300,000. Equipment would not be purchased in lots greater than US$300,000. The procurement of goods through shopping (national or international) will occur in accordance with Articles 3.5 and 3.6 of the World Bank Guidelines for Procurement. The first two contracts under international shopping and national shopping and any contract of more than $300,000 will be subject to prior Bank review. All other contracts will be subject to selective ex-post review by the Bank. 26  73. Procurement of Technical Assistance Services. All sub-components of the TA component will require consultant services either local or international or a combination of both, requiring several different contracts, a number of them for small amounts. The procurement of services will be according to the Bank Guidelines on the Use of Consultants (August 1981). A General Procurement Notice will be issued in June, 1996. 74. Contracts for consulting services of more than US$50,000 in the case of individuals and more than US$100,000 in case of companies will be subject to prior review by the Bank. Review by the Bank of the terms of reference would be carried out for all procurement of consultant services. It is expected that almost all the technical assistance packages will be procured on the basis of short- listing. In cases of small individual consultant short term assignments contracts, the packages will be procured through individual contracts. The results of consulting assignments, particularly plans of action for subsequent stages of project implementation would be submitted to the Bank for review. Table 1: Summary of Procurement Arrangements (US$ million) TA component ICB LCB Other Not Bank Total Financed Equipment 1I 1 Services 92 9 Equipment will be procured by international or national shopping. 2 Services will be procured according to the Bank's Guidelines on the Use of Consultants (August 1981). Procurement under Adjustment Component 75. In accordance with the February 8, 1996 Operational Directive on the Simplification of Disbursement Rules under Structural Adjustment and Sectoral Adjustment Loans the proposed EDAL proceeds will now be disbursed against satisfactory implementation of the adjustment program, including compliance with stipulated tranche release conditions and achievement of a satisfactory macroeconomic framework. Disbursements will not be linked to any specific purchases: hence, evidence will not be needed to support disbursements, nor will procurement requirements be needed. The standard negative list will be applied. Disbursement of Investment Component (Technical Assistance) 76. Disbursements would be administered by the PIU within the SPF. To facilitate project implementation, the SPF would establish a Special Account in one of the major foreign commercial banks on terms and conditions satisfactory to the Bank to cover the Bank's share of expenditures. The authorized allocation would be US$1 million. Applications for replenishment of the Special Account would be submitted monthly or when one-third of the amount has been withdrawn, 27  whichever occurs earlier. Documentation requirements for replenishment would follow the standard Bank procedure as described in Disbursement Handbook, Chapter 6. Monthly bank statements of the Special Account which have been reconciled by the Borrower would accompany all replenishment requests. 77. The proceeds of the TA component of the loan would finance 100 percent of consultants' services, 100 percent of foreign expenditures for office equipment, 100 percent of local expenditures ex-factory and 75 percent of other local expenditures for items produced locally. Expenditures for individual contracts would be disbursed against Statements of Expenditures for contracts below US$50,000 and expenditures for consultancy firms for contracts below US$100,000. All disbursements above the thresholds would be made against fully documented withdrawal applications. The documentation to support these expenditures would be retained by the SPF for at least one year after receipt by the Bank of the audit report for the year in which the last disbursement was made. This documentation would be made available for review by the auditors and the Bank upon request. The minimum size of withdrawal application for withdrawals directly from the loan account or issuance of the Special Commitments is 20 percent of the amount of authorized allocation to the Special Account, or US$20,000. 78. The Project is expected to be completed by December 31, 1998. The proposed closing date is December 31, 1999. Disbursement of Adjustment Component 79. The Government of Ukraine will open and maintain an account at the National Bank of Ukraine upon Bank notification of the release of each tranche. Proceeds of the loan will be deposited by the Bank in this account at the request of the Government of Ukraine by the submission of a simplified withdrawal application. If after deposit in this account, the proceeds of the loan are used for ineligible purposes (i.e. to finance items imported from a non-member country, or goods or services on the standard negative list), the Bank will require the Government of Ukraine either to (a) return that amount to the account for use for eligible purposes or (b) refund the amount directly to the Bank, in which case the Bank will cancel an equivalent undisbursed amount of the loan. Reporting and Auditing 80. The project manager will be located in the Ministry of Finance and would have different responsibilities for each component of the EDAL. For the adjustment component, the Project Manager will be responsible for submitting to the Bank the simplified Application for Withdrawal form upon receiving clearance from the MU and the Bank that all conditions have been met for a tranche release, and the Project Manager will maintain the project accounts. Although the Bank will not routinely require an audit of the Deposit Account it reserves the right to require an independent audit by auditors acceptable to the Bank. For the investment component the Project Manager is responsible for maintaining the project accounts. Qualifications and terms of reference of a Project Manager acceptable to the Bank were agreed before Negotiations. 28  81. The Government has recently established an interministerial steering committee consisting of ministers and deputy prime ministers. This committee meets monthly to monitor the use of foreign credit. It is not expected that this committee will influence the implementation of the EDAL. Project Sustainability 82. The main objectives of the loan are to accelerate the irreversible transformation in the ownership structure and management of Ukrainian enterprises, to accelerate the development of the private sector in Ukraine and to create capital markets infrastructure that will serve Ukraine indefinitely in the future. By definition these objectives are to bring about sustainable change. Lessons Learned from Previous Bank Involvement 83. The experience of the Rehabilitation Loan, as well as the preparation process for this loan (EDAL), has shown that well designed policy conditionality in the area of privatization can bring about dramatic reforms that were previously unobtainable, particularly when acting closely alongside grant financed technical assistance from other donors. Very close cooperation is being and will continue to be maintained with the other donors during loan preparation and execution, especially with respect to planned TA activities. The major donors have participated, along with Government, in the design of the project and have expressed their strong support for it. Also previous experience as well as experience gained during the preparation of this loan have shown that project preparation is a valuable opportunity to deliver hands on assistance to Government authorities in defining and dealing with operational issues in both design and implementation. Experience has also shown that Ukraine is unlikely to wish to borrow large amounts for TA and is likely to be able to mobilize substantial grant funds for this purpose. For this reason the TA component is small and limited to critical areas not financed by other donors. Environmental Aspects 84. The loan will have no direct environmental impact. Program Objective Categories 85. The proposed project supports the Bank's program objectives of development of a policy framework conducive to fiscal and macroeconomic stability, and to private sector development. Benefits and Risks 86. Benefits. The implementation of the reform program would represent major progress in removing the structural deficiencies and inefficient activities of the gigantic state enterprise sector inherited from the Soviet era. It would help bring the dynamic informal sector into the economic mainstream and move Ukraine substantially and irreversibly through the transition to a market economy. It would provide a basis for well-functioning capital markets and a critical mass of private enterprises that will be a main driving force for economic recovery. Given Ukraine's human and physical potential the economic benefits to be obtained from these reforms could be enormous. The 29  loan would also provide critical balance of payments support to finance imports needed for economic recovery. The channeling of the loan funds would support the new foreign exchange markets in Ukraine. 87. Risks. The most important risk is the possibility of loss of policy commitment due to lack of consensus and possible growing opposition among key constituencies. Further trade and price liberalization and the privatization and restructuring of the enterprise sector will strike at the heart of the old order and of the structural problems of the economy. Entrenched interests will be challenged. The changes, although necessary and very urgent, could be painful to certain sections of the population, particularly in those areas where large enterprise closures could occur. This risk of policy reversal will be higher if lost employment opportunities are not quickly replaced by new ones. The relationship between Parliament and Government is an uneasy one and Parliament has on several occasions declared itself openly hostile to mass privatization and market reforms in general. The most important factor mitigating the risk of loss of political commitment is the likelihood, based on the experience of other countries, that once market reforms have taken hold and a critical mass of enterprises has passed through the privatization process the reform process will be seen to benefit the population, gather momentum and be difficult to reverse. 88. Another important risk is that the SPF and other agencies responsible for implementing the program will not have the capacity to do so. Few countries in history have attempted to implement such an ambitious program and there is no experience in Ukraine and little anywhere else in doing so successfully. This risk has been taken into account in the program design by simplifying it and maximizing bottom up incentives and initiatives, capitalizing on the dynamics that already exist within the enterprise sector. The use of external technical assistance has also been planned to help in key implementation areas and relieve bottlenecks such as running the auction centers, drafting of laws and procedures and setting up capital markets institutions. 89. The third risk is that the benefits of the program may not appear immediately, that economic recovery may be delayed and that donor commitment may start to wane. This would make the inevitable adjustment process in Ukraine even more painful. The Bank will continue to attempt to reduce this risk through its donor coordination activities. Recommendation 90. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and I recommend that the Executive Directors approve it. James D. Wolfensohn President Washington, DC June 3, 1996 30  ANNEX 1 May 28, 1996 Mr. James D. Wolfensohn President International Bank for Reconstruction and Development Dear Mr. President: According to arrangements between the Government of Ukraine and the World Bank on strategies for helping Ukraine, and as a result of the negotiations held, we are hereby transmitting to you our Memorandum on Enterprise Sector Development Policy. The Memorandum outlines the Government's action program aimed at ensuring the creation and maintaining of a competitive environment, the rapid and effective privatization of enterprises and creation in the near future of a viable legislative base and infrastructure for the capital markets. Government is also taking steps to maintain a stable macro-economic environment, consistent with the need for economic growth, since this will be an important pre-condition for successful implementation of the economic reform program. The Government of Ukraine applies to the International Bank for Reconstruction and Development to support the above mentioned program, which has already begun, with an Enterprise Development Adjustment Loan in an amount equivalent to US$310 million. Sincerely yours, Roman Shpek Deputy Prime Minister 31  ANNEX 1 UKRAINE: ENTERPRISE DEVELOPMENT ADJUSTMENT LOAN Memorandum on Enterprise Sector Development Policy In October, 1994, Ukraine began a radical and comprehensive economic reform program which includes the promotion of the private sector as the main engine of market led growth. A first and important step in achieving this will be the privatization of the very large existing state enterprise sector which was inherited from the centrally planned economy of the Soviet Union. Also for these enterprises to operate effectively it will be necessary to maintain a competitive environment. A next important step will be to encourage the restructuring of these newly privatized enterprises. Experience in other countries that have implemented mass privatization programs has shown that capital markets should also be developed concurrently with implementation of mass privatization to allow the millions of new shareholders to trade their shares, to facilitate ownership restructuring and to promote the mobilization of new equity investment in the enterprise sector. In this memorandum we outline in detail the steps we already have taken and propose to take to ensure that a competitive environment has been created and will be maintained, that enterprise privatization is implemented rapidly and effectively and that a well-functioning capital markets regulatory framework and infrastructure is created rapidly. As an essential underpinning of these actions we intend to maintain a stable macroeconomic environment conducive to economic growth. Maintaining a Competitive Environment For the emerging private sector to contribute to economic recovery, a strong competitive framework needs to be in place. Through such early measures as trade liberalization and the deregulation of most prices, Ukraine's reform program has limited the direct role of the state in the economy, and has gone far in establishing competitive markets. However, competitive pressures still need to be increased further. The external trade regime is a crucial element of introducing competition in the economy, and much has been accomplished in this area since the October 1994 reforms were launched. Ukraine has unified its exchange rate and established convertibility for most current account transactions. The Government has also liberalized the trade regime by eliminating quotas and licenses. Other export restrictions have also been lifted, including export registration requirements (except for goods subject to international contingent agreements, Voluntary Export Restraints, anti-dumping investigations, goods covered by the Special Export Regime and livestock, skins and ferrous metal scrap). Indicative prices on exports have been abolished except in cases where anti-dumping charges have been brought and in the case of voluntary export restraints and livestock, skins and ferrous metal scrap. By end- 1996, it is planned to rescind the Special Export Regime and all remaining export registration requirements will also have been eliminated except for international contingent agreements, registration of export agreements under VERs and actual anti-dumping investigations. No barriers to exports will remain in place. On the import side, Ukraine has established a relatively liberal trade 32  ANNEX 1 regime. The trade-weighted average tariff is approximately 6 percent, and since January 1995 very few import duties above 30 percent have been introduced. No quantitative restrictions are in place. There is licensing for some chemical and pharmaceutical products for health and environmental protection purposes. By the end of 1996 quality certification will no longer take place at the import stage: it will be applied equally to imported and domestically produced goods by random checks at the wholesale or retail levels irrespective of origin. The Government is committed to maintaining this liberal trade regime: no new barriers to exports or imports will be introduced. On the domestic front, the Government has gone far in liberalizing domestic prices and removing administered controls in the economy. Adjustments in energy prices over the last year to world-equivalent levels have brought prices several times higher for industrial consumers. Phased reductions in subsidies for housing, communal services, energy and local transport are being implemented. Cost recovery from the population for these goods and services was raised to at least 60 percent in January 1996 and will be raised to 80 percent in mid-1996. The system of state orders has been abolished at the national level, and state purchases, based on competitively established contractual obligations, are now confined to the needs of budgetary organizations. The majority of ceilings on trade mark-ups as well as profit margin restrictions have been eliminated. The remaining restrictions on profit and trade margins in the grain and bread products sectors have-also recently been removed. Moreover the number of broadly defined categories of "artificial monopoly" goods for which price changes must be declared (approved) in advance has recently been reduced from 16 to 9. Phased demonopolization will take place during 1996 and price regulation of "artificial monopolies" will be eliminated by end-1996. At the beginning of 1997 the Price Inspection Units will accordingly be limited to monitoring a small number of goods and services typically produced by the public sector. Further strengthening of the competitive environment will continue in 1997 and beyond. Privatization Presidential Decree No. 699 of November, 1994 radically streamlined the procedures for mass privatization in Ukraine. It mandated that 8,000 medium and large enterprises would be privatized. It gave a full mandate to the SPF to implement this program, taking branch ministries out of the privatization process. It created a single simplified privatization process. It provided for simplified standard enterprise preparation packages to be completed by each enterprise according to tight deadlines, mandated that book value and most recent inventory should be taken as the valuation of the enterprise, provided for standard allocation of blocks of shares to the auction process and provided for a simple bidding system. A widespread public information program was initiated in early 1995 and an auction center network was created throughout Ukraine. Enterprise auctions started in January, 1995 and the numbers of enterprise shares put up for auction was gradually increased from month to month. Last year the Cabinet of Ministers approved a full list of the 8,000 enterprises to be privatized. In compliance with Presidential decree number 19 of March 19, 1996 "On Objectives and Peculiarities of State-Owned Property Privatization in 1996" important changes have been made in the process of privatization of state-owned enterprises. In particular (i) deadlines for the receipt (June 1, 1996) and full utilization (December 31, 1996) of privatization property certificates by the Ukrainian population were set; (ii) 33  ANNEX 1 additional incentives were granted for those enterprise managers who follow the required procedures and deadlines in the form of an additional 5 percent of shares on preferential terms; and (iii) permission was granted to delay the mandatory audit of enterprises undergoing privatization until the share allocation has been completed, thereby removing the delays in privatization because of audit requirements. In April, 1996 the State Property Fund issued an order to amend the share allocation plans of previously corporatized enterprises to comply with the existing methodology. Standard enterprise preparation documents have been prepared, approved and disseminated to all enterprises under preparation for privatization and measures have been taken to improve the transparency of the auction process by providing buyers access to the share allocation plans and by disseminating auction results not later than three weeks after the completion of the auctions. As of April 22, 1996 70 percent of the shares of 1663 medium/large enterprises had been transferred to private hands since January, 1995 and of these enterprises 34.1 percent are enterprises of the agro- industrial complex. By June 15, 1996 at least 70 percent of the shares in 2,000 enterprises will have been transferred to private hands. Of these at least 30 percent will be agro-industrial enterprises. In 1996 the Government introduced compensation certificates, which were distributed to all citizens who had deposits in the Savings Bank and insurance policies in the State Insurance Company dating from January 1, 1992, indexing the value of these deposits by 2,200 times. These certificates are being traded for shares in the privatization auctions. A mechanism has been introduced to ensure market clearing at the compensation certificate auctions so that all shares auctioned are sold. By December, 1996 the Government plans to have transferred 70 percent of the shares of 3,500 medium and large enterprises to private hands since January, 1995. Of these at least 30 percent will be agro- industrial enterprises. The Government's intention is to transfer to private hands at least 70 percent of the shares in a total of at least 5,000 medium/large enterprises by early 1997 since January, 1995, at least 35 percent of which will be agro-industrial enterprises. The remaining 3,000 enterprises on the 8,000 list will be privatized by early 1998 and it is planned to extend the mass privatization process to additional enterprises. In addition the Government will identify, before early 1997, ten large monopoly enterprises and will complete their privatization by early 1998. 45 percent of the enterprises subject to mass privatization are agro-industrial enterprises. Under current legislation the process for their privatization can take up to a year and a half. The President of Ukraine has three times vetoed a Law proposed by Parliament which would have had an additional serious negative impact on the speed and effectiveness of the privatization of these enterprises. Within the existing legal framework, however, steps have been taken to speed up the privatization of these enterprises and the results show that these steps are working. The Chairman of the State Property Fund issued a formal instruction to SPF officials at the SPF Collegium on March 26, 1996 to make the privatization of agro-industrial enterprises a top priority. To accelerate the privatization of agro-industrial enterprises further the Government intends to implement a methodology applicable to these enterprises similar to that which applies to medium and large enterprises in other sectors. This methodology will (i) shorten the corporatization and subscription period; (ii) ensure that no privatization transactions for these enterprises will be 34  ANNEX 1 retroactively reversed; and (iii) ensure that any shares in these enterprises transferred to primary producers of agricultural raw materials are transferred to physical persons and not to any collective structure. Small scale privatization is a much more decentralized process than that for medium and large enterprises and depends much more on the degree of support from local administrative bodies. However the Government is strongly committed to maintaining the accelerated rate of small scale privatization and during 1995 modified the procedures to achieve this. Important changes included a two month extension of the period granted to lease holders to buy out their enterprises at book value and allowing all employee buy-outs to take place at book value. Small scale privatization has been proceeding at the rapid rate of about 1,500 enterprises per month. Government's intention is to maintain the current favorable policy and methodological framework for small scale privatization and to complete the process in Ukraine by the end of 1996. Capital Markets Development In mid-1995 the capital markets trading infrastructure and regulatory framework in Ukraine was only rudimentary in comparison with the large number of enterprise shares that were already in private hands and available for trading, the growing number of shares being issued every week as a result of the mass privatization program and the growing number of investment companies and other market players who had become active. The Government is strongly aware of the need for efficient, well regulated capital markets as a means of enabling enterprise ownership changes promoting restructuring and better governance in the period following mass privatization as well as in mobilizing new equity investments. Furthermore it is necessary to protect Ukrainian and foreign investors in Ukraine from capital markets frauds. The Government took pioneering action during 1995 to begin building an adequate legal and institutional structure for capital markets operation and supervision in Ukraine. Preparatory work was completed and then a Presidential decree created a Securities and Stock Market Commission (SSMC) which will soon be regulating the activities of the capital markets in Ukraine. The SSMC was staffed and has now begun operations. In late 1995 and early 1996 Presidential decrees were issued transferring responsibility to the SSMC for the regulation of investment funds and companies and of registrars and depositaries. During the first half of 1996 we prepared draft normative acts governing investor protection and the operations of registrars depositaries and ci odians, broker/dealers, trading systems and self-regulatory organizations. These drafts will be enacted before the end of 1996. Temporary share registry units are already operating at each of the regional auction centers. A network of private, independent registrars will begin to take over during the second half of 1996. The number of independent registrars which comply with the Securities and Stock Markets Commission Regulation on Registrars of Securities has been increasing. The temporary databases of shareholders currently at the auction centers will be transferred to independent registrars. A plan for the creation of a depositary system for securities is being prepared and the depositary will begin operations during 1997. 35  ANNEX I In the second half of 1996 the legal framework will be complete for self regulatory organizations (SROs) for capital markets participants along the lines of SROs which exist in developed market economies. These organizations will have strict codes of conduct for members and by early 1997 membership of these SROs will be compulsory for all market participants. 36  ANNEX 2 IUKRAINE: ENTERPRISE DEVELOPMENT ADJUSTMENT LOAN Policy Matrix AREA/ I STATUS AND MEASURES TAKEN MEASURES TO BE TAKEN BY SECOND MEASURES TO llE TAKEN BY THD OBJECTIVES BEE)RE BOARD PRESENTAITON TRANCHE TRANCHE (estinated MARCH 31,1997) (estimatd NOVEMBER 30, 1996) 1. MACROECONOMIC STABILIZATION To create a stable macroeconomic Satisfactory progress on the implementation Satisfactory implementation of the stabilization Satisfactory implementation of the environment conducive to economic of the standby arrangement with the IMF. program. stabilization program. growth. 11. COMPETITIVE ENVIRONMENT A. External Trade Liberalization To promote exports, vital for output A draft law to eliminate the Special Export Continued liberalization of the external trade Ensure that there is no reversal of the trade recovery, and to foster competitive Regime was submitted to Parliament in April regime as evidenced by: liberalization measures implemented under markets through import competition. 1995. the Rehabilitation Loan and under the first - rescinding the Special Export Regime and second tranches of the EDAL. Preferential tax treatment of barter has been - ensuring that no new barriers to exports are eliminated. introduced Export quotas and licenses have been - eliminating all export duties eliminated but a recent Law has imposed export duties on live animals and skins and - eliminating export registration requirements and the Government continues to impose a system indicative prices on exports with the exception of of 'indicative' export prices, which, although those exports subject to international contingent substantially reduced in number, are de facto agreements and voluntary export restraints as mandatory. A Presidential decree was issued well as those under actual anti-dumping in late February, 1996 limiting the impositio,n investigations of minimum prices to certain categories. A list of 14 narrowly defined categories of exports subject to indictative prices was published on May 8, 1996. Besides goods subject to anti-dumping cases in Ukraine, VERs and international contingent agreements, this list includes livestock, skins and ferrous metal scrap. In addition some goods, although reduced in number, are also still subject to export registration.  ANNEX 2 AREA/ STATUS AND MEASURES TAKEN MEASURES TO BE TAKEN BY SECOND MEASURES TO BE TAKEN BY THIRD OBJECTIVES BEFORE BOARD PRESENTATION TRANCHE TRANCHE (estimated MARCH 31, 1997) (estimated NOVEMBER 30, 1996) QRs on imports have been removed, with a - ensuring equal treatment of imported and few exceptions, primarily for health and domestically produced goods with respect to the safety reasons. However, the existing same standards, by abolishing the requirement practice of goods requiring quality for certification at the import level and certification and compliance with Ukrainian substituting instead with random checks of standards is applied at the import stage which affected goods at the wholesale or retail levels causes importers difficulties. The irrespective of their origin Government maintains a fairly liberal import tariff regime. The trade-weighted average tariff is below 6%. The maximum import duty is 30% with exceptions of higher duty rates accounting for 0.03% of imports in 1995. B. Price Liberalization To liberalize all prices except for a Government has abolished the majority of Continued liberalization of price regime as Ensure that there is no reversal in the price w few natural monopolies. Regulated state interventions in price setting, including evidenced by: liberalization measures implemented under oo prices to be set so as to fully recover direct price controls, and most ceilings on the Rehabilitation Loan and under the first the cost of providing the good or profit margins. and second tranches of the EDAL. service. Prices remain regulated for public utilities, - abolishing price regulation on all remaining public transport, rents, and for categories of artificial monopolies goods produced by 'artificial monopolies". Producers of goods and services in the "artificial monopoly" category must notify MOE authorities of all price changes. Recently, the number of categories of goods produced by artificial monopolies that are subject to price regulation has been reduced from 16 to 9. Moreover, the remaining restrictions on profit and trade margins on grain and bread products were removed in May 1996.  ANNEX 2 AREA/ STATUS AND MEASURES TAKEN MEASURES TO BE TAKEN BY SECOND MEASURES TO BE TAKEN BY THIRD OBJECIIVES BEFORE BOARD PRESENTATION TRANCHE TRANCHE (estimated MARCH 31, 1997) (estimated NOVEMBER 30, 1996) Oblasts have no legal authority to regulate - penalizing any discretion at the local level to prices of additional 'artificial' monopolies, impose price controls although in practice some may try to do this for limited periods of time. - the function of the Price Inspection Units at the state and regional levels will accordingly be There is a separate Price Inspection Unit limited to monitoring a small number of goods reporting directly to the MOE, with and services typically produced by the public corresponding staff at the regional level sector charged with enforcing price controls. De facto, regional staff appears to spend most of its time monitoring costs at communal service enterprises. III. IMPLEMENTATION OF ENTERPRISE PRIVATEZATION PROGRAM A. Mass Privatization Implementation of streamlined The Cabinet of Ministers approved two lists w procedures for mass privatization of of a total of 8000 medium and large-scale SOEs via certificate auctions as laid enterprises to be privatized through certificate out in President's Decree No. 699 of auctions. November 1994. The State Property Fund developed standard enterprise preparation documents and disseminated them to enterprises. Pre- existing share allocation plans for already corporatized enterprises were revised in order to bring them into line with new standard documents and to ensure that all shares remaining after privileged sale to workers will be offered for auction.  ANNEX 2 AREA1 STATUS AND MEASURES TAKEN MEASURES TO BE TAKEN BY SECOND MEASURES TO BE TAKEN BY THIRD OBIECTIVES BEFORE BOARD PRESENTATION TRANCHE TRANCHE (estimnated MARCH 31, 1997) (estimated NOVEMBER 30, 1996) Completion of infrastructure and The network of over 1,000 bidding centers refinements in the implementation was completed thereby ensuring access to all procedures for mass privatization. citizens and improving demand for enterprise shares at auction. The sale of enterprise shares for savings indexation certificates began with savings indexation certificates and privatization certificates used in the auctions, as approved by the Cabinet of Ministers. Implementation of streamlined privatization Formal rules streamlining agro-industrial procedures for agro-industrial enterprises enterprise privatization will be enacted. began. To ensure that all of enterprises' The auction mechanism for compensation shares are transferred to private certificates was modified to allow complete owners so that the state does not auction clearing regardless of the number of o continue to hold shares and exercise bidders. management authority over enterprises. Improved public information on and The SPF issued an order requiring that: transparency of the privatization process. 1. full share allocation plans be published before auctions; and 2. auction results be published within three weeks of completing the auctions. Maintenance of steady, rapid Privatization of more than 2000 Privatization of 3,500 medium/large enterprises Privatization of 5,000 medium/large momentum of and the eventual medium/large enterprises completed and completed and majority (between 70 and 100 enterprises completed and majority (between completion of mass privatization and majority (between 70 and 100 percent) of percent) of shares of these enterprises transferred 70 and 100 percent) of shares of these the initiation of a second phase of shares of these enterprises transferred into into private hands, since January, 1995. Of these enterprises transferred into private hands, privatization addressing difficult private hands, since January, 1995. Of these, 30 percent will be agro-industrial. since January, 1995. Of these 35 percent cases such as monopoly enterprises, 30 percent are agro-industrial. will be agro-industrial. infrastructure objects. The identification of at least 10 large monopoly enterprises and the initiation of work on privatization plans so that these enterprises will be privatized in during 1997.  ANNEX 2 AREA/ STATUS AND MEASURES TAKEN MEASURES TO BE TAKEN BY SECOND MEASURES TO BE TAKEN BY THIRD OBJECTIVES BEFORE BOARD PRESENTATION TRANCHE TRANCHE (estimated MARCH 31, 1997) (estimated NOVEMBER 30, 1996) B. Small-Scale Privatization To accelerate the privatization of The period of validity of the President's No reversal in the favorable legal, institutional No reversal in the favorable legal, small-scale enterprises. Decree on small-scale privatization offering and methodological framework governing small institutional and methodological framework favorable direct buy-out terms and incentives scale enterprise privatization and continued rapid governing small scale enterprise to leaseholders to allow enterprises to be progress in implementation. privatization and continued rapid progress in privatized by competitive means was implementation. extended by 3 months to September 1, 1995. Amended valuation methodologies so that the purchase price of leased enterprises was reduced to book value. Instructions to local privatization bodies not to renew leases on small scale enterprises. Eliminated requirement that privatized small scale enterprises should maintain existing product ranges. Disciplinary action taken against local officials who do not implement instructions on small scale privatization. IV. DEVELOPMENT OF CAPITAL MARKETS Creation of an independent Securities The SSMC was created. SSMC and Stock Markets Commission Commissioners were elected; a budget and an (SSMC). organizational structure approved. Complete staffing of the SSMC. Key departmnents essentially staffed, i.e., SSMC fully staffed. legal, licensing, supervision, corporate frnance. Creation of Self-Regulatory Legal framework for SROs adopted, a Code Organizations: of Conduct of market participants approved by the SSMC. - association of collective investmnent An Ukrainian Association of Investment A Code of Conduct adopted by UAIB. intermediaries. Businesses (UAIB) supported by USAID has SROs membership mandatory for all been registered and is accepting membership licensed market participants. applications.  ANNEX 2 AREA) U A ME ETAKE ME ASURES TO BE TAKEN BY SECOND MEASURES:TO RE T BY TWRD OBJCTIME B.:FPEO BORENTATON TRANCHE TRA(simad MH3.1997) (estimated NOVEMBER 30, 1996) association of broker/dealers An initiative to create an association of broker/dealers is being supported by USAID. Creation of pilot independent Three pilots identified by TACIS consultants. Dissemination of know-how free of charge. Registrars for Shares. Three pilots identified by USAID consultants. Dissemination of know-how free of charge. Creation of transitional registrars for Transitional registrars operational. Phasing-out and/or privatization of transitional shares in Auction Centers. registrars. Creation of the National Depositary General NDS concept prepared. Standards for NDS adopted. NDS operational. System (NDS) including a National (Central) Depositary and a network Creation of the National Depositary as an of integrated privately operated local independent legal entity. depositaries. Introduction of crucial legislation for Decrees issued on regulation of investment All legislation adopted. All legislation made operational by the regulation of capital markets. funds and investment companies and of SSMC. 4> registrars and depositaries. Draft decrees prepared regulating capital markets in the areas of: -Investor Protection -Registrars, Depositories and Custodians -Broker/Dealers and their SRO -Trading Systems.  > l i | l l w~~~~~~~~~~~ l-'W