Reform of Ukrzaliznytsia: What Will Change in the Railway Monopolist and How, an Exclusive Interview

Andrii Bukovskyi, the head of the department of reform and corporate development at Ukrzaliznytsia, discusses the future of the railway monopolist, investors, private operators, and suburban transport in an exclusive interview with the CTS portal
Serhii Androschuk 22 March 2013 11:40

Andrii Bukovskyi has the complex and, at first glance, generally monumental task of reforming the Soviet relic called Ukrzaliznytsia. The reform, which entered the legislative phase at the beginning of last year, is already very close to realization – enactment of a government decree on establishment of the Ukrzaliznytsia joint-stock company is planned for next month and the joint-stock company will be registered six months later. What will this change on Ukrainian railways and what new opportunities will it open to passengers, shippers, and investors? We will discuss all this with the head of Ukrzaliznytsia’s department of reform and corporate development, Andrii Bukovskyi.

At what stage is the reform of Ukrzaliznytsia today?

Today, we are at the finish line of the first - in essence, the preparatory - phase, which was intended to create a legislative and regulatory framework for the operations of the Ukrzaliznytsia joint-stock company.

The second phase will begin with the establishment of the Ukrzaliznytsia joint-stock company. The relevant government resolution has already been prepared and agreed with all the ministries and agencies involved in this issue. We have also received the approval of our scientific community, trade unions, and international experts. Just last week, President of Ukraine Viktor Yanukovych signed the decree "On the National Action Plan for 2013 for Implementation of the 2010-2014 Economic Reform Program." According to this document, the resolution is scheduled to be issued next month. The future joint-stock company should be registered in October with 100% of its shares owned by the state.

What model was chosen as the basis for the reform of Ukrainian railways?

There are two main models in the world. The essence of the first is that infrastructure, haulage, and carriers are separated from each other, with infrastructure owned by the state in most cases. That is the model used in many developed countries in Europe. Although such a reform scenario is consistent with the goals of market liberalization, this model does not quite fit countries with economies in transition from the viewpoint of feasibility and effectiveness. For us, division into three separate companies in a single step is highly problematic. In that case, there will be significant problems with maintenance of infrastructure and passenger transportation will be problematic. After all, the volume of cross-subsidization of passenger transport at the expense of freight transport at Ukrzaliznytsia is significant and could be up to USD 1 billion

Therefore, it was decided to build the business processes based on the second model. Locomotive haulage and infrastructure will remain in one company, but financial accounting will be divided vertically (in accordance with the directives of the European Union). Operation of railcars will be handled by affiliates, which will be part of the parent company only in the first year. In the future, they will enter the competitive market in the form of 100%-affiliated companies.

Other dependent joint-stock companies operating in competitive or potentially competitive segments (passenger transportation, suburban transport, and, possibly, paramilitary freight security, etc.) will be pushed into the market in the same way.

What is the difference from the reforms being implemented in Russia and Kazakhstan?

We are the closest to Russia, although the problems that we are trying to avoid are already visible. In particular, I am talking about excessive liberalization of the freight market. After all, they did not manage to achieve the same level of transportation when they increased the fleet of rolling stock by 20%, compared with the time of the collapse of the Soviet Union. At the same time, 15-17% of applications for transportation were not met. This was due precisely to an excessive number of small carriers, which independently operated their own fleets. As a result, there were traffic jams around the barriers in the transport network and an overload of the infrastructure in certain directions.

To avoid a similar situation, the new version of the Law of Ukraine on Rail Transport (which is expected to be submitted to the parliament in October) will contain a mechanism for protecting against such situations. One of the requirements that operators must meet during registration will be the size of the pool of railcars that operators are allowed to operate independently. We are proposing a limit of 5,000 railcars, although this figure is open to debate. However, these restrictions do not apply to complete train consignments and transportation in special railcars. Any legal or natural person will even be able to buy one railcar, but they will not be able to operate them independently. In such a case, operation of the railcar will be transferred to a private operator or any of our subsidiaries operating in this sector.

Like in Russia and Kazakhstan, we plan to create separate train paths for private operators

Are you talking about all types of railcars?

No, only about universal cars - gondolas, boxcars, and flat cars. According to plans, this rule will not apply to special cars (grain cars, cement cars, etc.) or in cases in which universal cars are used for complete train consignments.

As for Kazakhstan, they have gone furthest in the area of splitting and division into separate enterprises. In addition, they have separated medical and other social facilities, which we also do not plan to do.

Which segments of the industry will be primarily of interest to investors?

I would single out three groups of investors. The first is connected to the real sector of the economy. These are large enterprises operating mainly in the mining and metallurgical complex that use their own fleet of cars to transport their products. The new rules on the market will create favorable conditions for further investment in acquisition of rolling stock in order to create powerful transport subdivisions with their own repair facilities.

The second group consists of major international financial institutions - the EBRD, the World Bank, and others. They are largely interested in infrastructure projects, particularly electrification. Specific projects are already being negotiated, particularly Znamianka-Dzhankoi and Volnovakha-Zaporizhia. However, the key condition set by international financial institutions is creation of a joint-stock company because the current organizational structure of the Ukrainian railways is incomprehensible and opaque to them.

Can you provide a concrete example of this?

Of course, the acquisition of trains manufactured by Hyundai Rotem. Ukrzaliznytsia conducted the negotiations on the financial and economic aspects, as well as on the development and approval of the technical terms. However, the contract was concluded with the Pivdennyi Railroad, which is a separate economic entity, although it is under the control of Ukrzaliznytsia. After that, the rolling stock was transferred to the state-owned Ukrainian High-Speed Railway Company. This mechanism is complicated for investors, and it does not meet international business standards. If a joint-stock company is created, everything will fall into place and there will be clarity and transparency.

On what will the third group of investors focus?

On the passenger sector. Like in Russia and Kazakhstan, we plan separate train paths for private operators.

Can you estimate the total amount of investment required by Ukrzaliznytsia?

It is huge. UAH 68 billion needs to be spent on purchase of locomotives alone by the year 2020. Passenger transportation needs UAH 8.7 billion.

Our chronic underfunding is clearly visible from last year’s indicators, when our total requirement was estimated at UAH 27 billion but UAH 8.5 billion was actually spent. I think it is not necessary to spend a lot of time talking about the possible result of this. Put simply, there will be nothing with which to transport cargoes and passengers and ensure proper transport safety. Therefore, reform that will bring additional sources of investment is urgently needed by the railway industry.

When can suburban transport companies be expected to be created jointly with regional authorities?

In the second stage of the reform, when the appropriate regulatory framework has been created. According to the new version of the Law of Ukraine on Rail Transport, six suburban transport affiliates/directorates for will be authorized to conclude contracts with regional administrations. However, this provision is not mandatory - if the local authorities have no desire to take this step, then suburban transport will be performed within the scope of the amounts paid by the government.

Where will local authorities find the money if they are complaining today about their meager budgets and the chronic failure to compensate railways’ losses from transport operations?

If regional administrations are interested in development of suburban transport, then they have the opportunity to obtain credits for purchase of rolling stock, invite large enterprises that are interested mass transportation of their employees from the suburbs to participate, or look for other opportunities for development of suburban transport.

By the way, the prototype for such a company already exists in Kyiv. Good or bad, the model works, and more and more Kyiv residents and visitors to the city use its services every day.

What fate awaits the non-core assets?

Like what?

The assets that are unrelated to the core business

We do not have such assets. Even our social facilities are directly related to ensuring transport safety. After all, we have a technological process in which we need regular medical examinations. We no longer have educational institutions, but the “road technical schools” that train highly in-demand experts - welders and turners - for us remain. If we do not train them, we will have nowhere from which to take them.

Therefore, we do not see any non-core assets that should not be included in the authorized capital of the company. The Presidential Administration and the Cabinet of Ministers support this position. In case of possible emergence of surplus assets in the future, they will be redistributed or used during creation of joint ventures with local administrations, for example.

Who will perform asset valuation?

The Ministry of Infrastructure and Ukrzaliznytsia will organize a competition to select the appraiser company. The potential participants include the global corporations Ernst & Young, Deloitte & Touche, Baker & McKenzie, AT Kearney, and others.

By the way, there was a blessing in disguise: we were able to prepare for inventory and valuation of the assets more thoroughly because of the delay in adopting the Cabinet of Ministers resolution on establishment of the joint-stock company. In particular, technical valuation of the rolling stock for possible extension of its service life was completed. This, in turn, facilitates establishment of its real market value.

What is the role of Ernst & Young in the preparation for the next phase of the reform?

First, it should develop the target management structure for the Ukrazaliznytsia joint-stock company within one year after the creation of the joint-stock company and with an organizational depth up to the structural subdivision of the affiliate. Secondly, it will determine the main tasks and functions of these subdivisions, as well the rules for interaction between them. Thirdly, experts with Ernst & Young were to draft job descriptions for managers of the joint-stock company and the provisions on the structural subdivisions of the managerial apparatus and affiliates.

The target management structure and the basic functions of the subdivisions are practically ready today. They are expected to be submitted to the board of Ukrzaliznytsia for approval by the end of March.