The Difficulties of the Second Phase of Railway Reform In Ukraine

PJSC Ukrzaliznytsia board member Yevhen Kravtsov and head of Ukrzaliznytsia’s department of reform and corporate development Andrii Bukovskyi discuss when a railway freight company will be created and who opposes reform of Ukrzaliznytsia.
Serhii Androschuk 05 April 2016 17:30

The first stage of the reform, which involves merger of the assets of six railways and about 40 enterprises into the Ukrzaliznytsia public joint-stock company (PJSC Ukrzaliznytsia), was generally successful. An affiliated wagons and logistics company – a sort of blueprint for the Ukrzaliznytsia Cargo company – is expected to be spun off from it in the second half of 2016. However, further reform of the industry is in danger of stalling for several reasons.

Railway opposition It should be recalled that the need to reform Ukrzaliznytsia has been discussed for more than a decade. One of the main objectives is to separate the business functions from public administration functions and create distinct verticals based on functions – freight operations, long-distance passenger transportation, commuter passenger services, and maintenance of infrastructure.

“At the initial stage, it was necessary to make an inventory of all the assets under the control of Ukrzaliznytsia, and these were six railways and more than 40 enterprises,” said Yevhen Kravtsov, a member of the board of Ukrzaliznytsia. "Later, all these assets were merged into a single company. The largest company in our country – PJSC Ukrzaliznytsia – started operation on 1 December last year. Why is it the largest? Because it currently employs about 300,000 people, which is about 2% of the country’s working population.”

Problems arose in the company’s first months of operation, primarily because its personnel were not ready for structural reforms. It turned out that people were mentally not ready to change in both its central office and branch offices.

“This was probably due to the fact that reform was discussed for more than a decade, but its implementation did not begin. In addition, it is one thing to talk about reform and another thing to put it into practice. Specifically, there were technical and organizational problems with the operations of the company’s branches. Some of them had difficulty opening bank accounts. Moreover, procurement procedures were complicated. Previously, individual enterprises made their own procurements. Now, they need to coordinate their activities across the company. Those procurements that were exempted from the tender legislation because of their small volumes now automatically fall under the tender legislation because of their increased volumes across the company,” Kravtsov said.

In addition, it is necessary to talk about a certain degree of opposition from the managements of former railways, which are now regional affiliates of PJSC Ukrzaliznytsia. Since the essence of reform is to switch from the principle of regional management to the principle of vertical management, this means that the functions of each of the six railways will be gradually eroded and all functions will be concentrated in vertically integrated structures. Initially, these will be affiliates, but in the future, they will joint-stock subsidiary companies.

"Problems arose in the company’s first months of operation, primarily because its personnel were not ready for structural reforms"

Related: Ukrzaliznytsia Cargo will be the number one in Europe – Interview with Stefan Hofsaess

Freight first Basically, affiliates already exist and they will have a clear vertically integrated structure by the end of the first half of this year.

“For example, there is an affiliate called the Center for Repair and Maintenance of Track Machines, which will engage in repair of infrastructure and maintenance of track machines. Road repair facilities will be transferred to it in addition to regional centers. The same applies to the creation of the branch called the Main Computing and Information Center and an energy supply affiliate,” he said.

However, it should be noted that the formation of these entities does not require much effort. In fact, the blueprints for them existed at the central level in the form of independent subsidiaries before the creation of the Ukrzaliznytsia public joint-stock company. The moment of truth for reforms is the creation of vertical structures for the core operations. The Ministry of Infrastructure and the management of the joint-stock company are working actively on creation of a railcar logistics company.

“We expect a fully fledged structure in the form of an affiliate, to which a fleet of freight cars will be transferred, to be created before the end of the year. It will serve as a form of blueprint for Ukrzaliznytsia Cargo. Currently, there is debate within the joint-stock company about whether to transfer the entire fleet or leave some types of railcars in individual affiliates for now. Probably, locomotives will not be transferred to it at the initial stage. This will be the next step. In addition, there is a debate about whether the operator will simultaneously be the seller of its services on the market or whether these functions should be separated. We will possibly go the second route – the affiliate called Transport Logistic Centre will be in charge of sales. It will offer customers creation of supply chains with the involvement of other modes of transport. In addition, if the customer owns its fleet, then services involving the use of traction and infrastructure will be sold to it,” said Bukovskyi.

What and who hinders reforms? A number of reasons can cast doubt on implementation of further structural changes in the industry or, at the very least, slow their pace. In particular, changes are needed at the legislative level, specifically amendment of the laws of Ukraine "On Rail Transport" and "On Establishment of the National Transport Regulation Commission."

“All these laws were planned for adoption last year, the parliamentary vote on them is still under a big question despite the fact that all the necessary procedures have been completed,” Bukovskyi said.

In principle, adoption or non-adoption of new laws have no direct influence on the process of creation of vertically integrated structures within the public joint-stock company. However, these changes are necessary for creation of civilized rules of the game on the rail transport market. In particular, the law legalizes such things as a private traction, freight operator, and rail freight market.

“For fully fledged carriers to emerge, it is necessary to create a National Transport Regulation Commission, which would determine the tariff for use of infrastructure and a methodology for determining the other components of the tariff,” Bukovskyi said.

In addition, the law introduces the concept of placement of orders for social passenger transportation on both long-distance and suburban routes. The orders will be placed by a central government agency in the first case and by regional authorities in the second case.

Even if the laws are adopted, their introduction will be postponed for one year, as stipulated in the laws. Time is needed to prepare a sufficiently large number of by-laws.

In addition, the issue of creation of a State Rail Transport Agency is currently in limbo. That is to say that economic functions have already been transferred to the Ukrzaliznytsia public joint-stock company, but this agency should focus on implementation of state policy on transportation, monitoring of equal access to infrastructure, registration of carriers and operators, and coordination of their activities.

In addition, the prospect of abolishing cross-subsidization within the public joint-stock company is not yet under consideration. At least, the government is unlikely to take this step in the coming years in the current economic realities.

Another problematic issue is the issue of creation of the Donetsk Railways as the Ukrzaliznytsia public joint-stock company’s regional affiliate in Krasnyi Lyman.

“Its administration is currently being created. There are problems involving personnel, but they can all be solved. Nevertheless, creation of such a large regional branch from scratch requires additional time,” Kravtsov said.

Election-related risks Still, the reformers of Ukrzaliznytsia see light at the end of the tunnel. In their view, all the conditions necessary to implement structural changes within the public joint-stock company exist even under the current regulatory framework.

“Vertically integrated affiliates that will focus on their core operations should be established within the company during the period of 2017-2018. On the issue of their breakup into joint-stock companies, we are currently orienting toward the period of 2019-2021,” Kravtsov said.

The company is hoping that all the changes to the regulatory framework will not only have been adopted by that time, but also that they will pass the test of time. However, risks remain – the reform the industry may be postponed indefinitely again and limited to cosmetic changes on the eve of the presidential and parliamentary elections.