Naftogaz group is committed to implementing the highest standards and best international practices in corporate governance.
CORPORATE GOVERNANCE REFORM
In 2015, Naftogaz corporate governance suffered from significant shortcomings, including:
• The management of the company depended on certain political forces and did not always operate in the interests of the state;
• There was an unclear division of management functions including jurisdiction overlaps with the Cabinet of Ministers of Ukraine (CMU), the Ministry of Energy and Coal Industry, Ministry of Finance and other government bodies. This was particularly problematic for the internal audit process and the revision commission;
• The selection process of supervisory board members was opaque. Mechanisms and tools that could help to attract competent professionals with an impeccable reputation were not working;
• The appointment and removal of the leadership in Naftogaz and its subsidiaries, as well as remuneration of these persons, was determined by the government. This inevitably affected management decision-making.
To address these shortcomings, in 2015 Naftogaz continued to implement the corporate governance reform program started in 2014.
This ongoing reform process aims to create an efficient and transparent company which will protect the rights of the owner, establish an effective system of internal controls, eliminate political influence, and create a level playing field with commercial companies in the market in compliance with the principles of corporate governance set out by the Organization for Economic Cooperation and Development (OECD). Additionally, the reform of the corporate governance system of Naftogaz group subsidiaries was initiated in order to bring them into line with the group's new standards of corporate governance.
Reforming the corporate governance of Naftogaz companies in accordance with OECD principles of corporate governance is envisaged by the reform plan of the gas sector of Ukraine, which was approved by the CMU in March 2015, and agreed with the World Bank and the Energy Community Secretariat. This reform plan is a part of Ukraine's commitments under a loan agreement with the EBRD and a necessary step for the integration of Ukraine into the European Union. The success of this reform plan is essential for the future security of gas supplies in Ukraine and the rest of Europe.
In October 2015, the CMU approved the Corporate Governance Action Plan for Naftogaz (CGAP). The first phase of the plan was implemented in December 2015. This involved the adoption of a resolution by the CMU dated 5 December 2015 (No. 1002 "Issues to improve corporate governance of public joint stock company "National Joint Stock Company "Naftogaz of Ukraine").
In accordance with the OECD Guidelines III.A:
• Interference and obstruction of economic activity by state bodies, political parties and public organizations, their officials and officers is prohibited;
• It is established that the company is a full shareholder (founder, member) of business companies whose shares are transferred to the authorized capital of the company as well as of those that were founded by the company or whose shares were acquired by other means. The company has all rights and bears all shareholder responsibilities (founder, member) in accordance with the law. The company will exercise management of corporate rights (shares, stocks) of legal entities of which it is a shareholder (founder, member), independently through its authorized bodies under the Charter1.
In addition, the CGAP contains a list of measures aimed at ensuring:
• Independence from political influence. To this end, draft laws and amendments to existing regulatory instruments were adopted that clearly define the spheres of influence of any state bodies on the management of the company and its activities. Ideally, this influence would be reduced to a minimum;
• Implement the rights of the owner. According to the developed model, the functions of the state as owner and sole shareholder of Naftogaz must be exercised by one public authority.
Operation of complete and independent supervisory board;
• Establishment and effective functioning of internal controls of Naftogaz. The CGAP provided for the implementation of the appropriate internal policies and functions, and the appointment of key executives such as a director for risk management, compliance manager for authorized anti-corruption programs etc.
During the implementation of the corporate governance reform plan, Naftogaz has compiled with gender equality principles. In cases where two candidates are deemed to have equal qualifications for a position, preference is given to the minority gender.
Resolution No. 1002 approved transitional (effective by April 2017) and target charters (to be effective from 1 April 2017) for the supervisory board and executive board rules of procedures. It also provided the basis for further reforms, including the following:
• In order to separate ownership from policy-making, 100% of shares were transferred from the Ministry of Energy and Coal Industry to the Ministry of Economic Development and Trade (instead of the CMU). Later it was decided to transfer 100% of the company's shares to the CMU, as stipulated in the CGAP;
• The final stage of the corporate governance reform plan, which provides for the full scope of powers for the supervisory board, including the election and removal of the chairman and members of the executive board, approval of the strategy, budget and scope of risks, is scheduled;
• The following supervisory board committees are envisaged: audit committee, nomination and remuneration committee, and ethics committee;
• The supervisory board received wider powers, including approval of the company's mission, the election and removal of the chairman and members of the executive board, approval of the company's business plan, in particular the financial plan (budget) and the investment program;
• An independent nomination committee must be formed in order to select qualified candidates for the position of supervisory board members, particularly independent directors.
On 22 September 2016, the government decided to transfer control over Naftogaz to the CMU.
GOVERNING BODIES OF THE COMPANY
The governing bodies of the company refer to the general meeting of shareholders (the highest administrative body that has the right to decide on all company matters, including those within the competence of other bodies), supervisory board (a body which, according to Article 51 of the Law of Ukraine "On Joint Stock Companies", protects shareholders" rights and the interests of the company. Within its competence, it oversees and regulates the activity of the executive body) and the collegial executive body — the executive board headed by the chairman of the executive board.
In 2015, the supervisory board consisted of 11 members — representatives of ministries and departments. This supervisory board was elected in 2013 by order of the Ministry of Energy and Coal Industry of Ukraine. The supervisory board had no independent directors. In practice, in 2015 the supervisory board of the company did not perform its functions under the terms of the law and the Charter of the company. Instead, issues were resolved by the Ministry of Energy and Coal Industry as the body that managed the state's corporate rights at the time.
SUPERVISORY BOARD APPROVAL PROCEDURE
According to Resolution 1002, the current supervisory board of Naftogaz includes five people, three of whom must meet the independence criteria established by the law and rules of procedure on the supervisory board of the company. One member is appointed in agreement with the Cabinet of Ministers of Ukraine, and one in agreement with the President of Ukraine.
Proposals for the nomination of candidates for the supervisory board must be made to the Ministry of Economic Development and Trade of Ukraine. These proposals must come from the committee for the appointment of senior managers for state-owned companies formed in accordance with the procedure for competitive selection of managers in the public sector, approved by the Resolution of the Cabinet of Ministers of Ukraine dated 3 September 2008 (No. 777). Candidates nominated before the Ministry of Economic Development and Trade are independently selected by this committee, if necessary, with the assistance of recruitment specialists and according to the criteria set out by law, the company Charter, and the rules of procedure established by the supervisory board.
The appointment of members of the supervisory board lies within the competence of the general meeting of shareholders and was exercised by the Ministry of Economic Development and Trade of Ukraine as a shareholder of the company.
However, the CGAP envisages approval of the state ownership policy for Naftogaz (usually this is a policy based on the general ownership policy for state enterprises that describes the basic expectations of the state as the owner of the company) and nomination policy to the supervisory board and its expected performance.
RECENTLY ELECTED NAFTOGAZ SUPERVISORY BOARD
For the selection of independent candidates as supervisory board members, Naftogaz engaged international recruitment agency Odgers Berndtson, whose work was funded by the European Bank for Reconstruction and Development.
As a result, the following persons were elected to the Naftogaz supervisory board:
• Yulia Kovaliv, chairperson of supervisory board;
• Paul Warwick, deputy chairperson of supervisory board — independent director, chair of the nomination and remuneration committee Dr. Marcus T. Richards, member of supervisory board — independent director, chair of the ethics committee;
• Charles Proctor, member of supervisory board — independent director, chair of the audit committee;
• Volodymyr Demchyshyn, member of supervisory board.
SUPERVISORY BOARD COMMITTEES
In 2015, the supervisory board was not carrying out its functions. Instead, issues within the competence of the supervisory board were resolved at the general meeting of shareholders. Due to the practical absence of the supervisory board, no supervisory board committee existed. The new rules of procedure of supervisory board that were adopted in December 2015 included the following committees: audit committee, nomination and remuneration committee, and ethics committee. These new rules stipulated that the chairperson and majority of the supervisory board committees must be independent directors. At the time of compiling this report (September 2016), such committees have been established with independent directors as chairs.
The supervisory board began operating in 2016. At the first meeting on 11 May 2016, with the participation of independent directors Paul Warwick, Charles Proctor and Dr. Marcus T. Richards together with state representatives Yulia Kovaliv and Volodymyr Demchyshyn, the chairperson of the supervisory board was elected — state representative Yulia Kovaliv. Independent director Paul Warwick became the deputy chairperson of the supervisory board. The structure of each of the three committees included all members of the supervisory board, and in accordance with the requirements of the Naftogaz Charter, independent directors also headed these committees. Charles Proctor was elected chair of the audit committee. Dr. Marcus T. Richards headed the ethics committee, while Paul Warwick led the nomination and remuneration committee.
FINANCIAL CONTROL AND PERFORMANCE MONITORING WITHIN THE COMPANY
Given the strategic importance of the company for the Ukrainian economy and its important social role, monitoring the activities of Naftogaz is periodically or continuously carried out by various state agencies as cameral, desk and ex-post audits. Additionally, the state government, through the State Financial Inspection Service, exercises permanent direct control over the daily activities of Naftogaz. For this purpose, the premises of the company feature a dedicated permanent office for State Financial Inspection officials.
According to the preliminary version of the Naftogaz Charter, effective until December 2015, review of financial and economic activity was carried out by the revision commission of 5 persons elected by the general meeting of shareholders (at the time — the Ministry of Energy and Coal Industry) upon agreement with the Cabinet of Ministers of Ukraine. The composition of the revision commission was last approved in October 2013. It featured representatives of the Ministry of Energy and Coal Industry, National Energy and Utilities Regulatory Committee (NEURC), State Financial Inspection, and the Ministry of Income and Fees (the State Fiscal Service). However, due to the dismissal of the head of the revision commission from the Ministry of Energy and Coal Industry and the failure to appoint a new officer, revision commission meetings were not conducted and the commission did not perform its functions as such.
The management of Naftogaz therefore took measures to terminate the powers of the current revision commission of the company.
Ultimately, to bring Naftogaz corporate governance into line with the OECD Principles of Corporate Governance, the Cabinet of Ministers of Ukraine adopted a resolution dated 5 December 2015 (No. 1002: "Issues to improve corporate governance of the public joint stock company "National Joint Stock Company "Naftogaz of Ukraine"), which does not provide for an audit committee as an organ of the company.
According to the new version of the Naftogaz Charter, the functions of the revision commission in terms of control over the financial and economic activity of the company are assigned to the supervisory board audit committee and other bodies and functions of the company that are part of the internal control system.
An independent audit was conducted into the financial statements of Naftogaz for 2015 by PJSC Deloitte and Touche USC, which confirmed that the stand-alone financial statements fairly present in material aspects the financial position of the company as of 31 December 2015 (see section Financial Statements).
Ukrainian legislation provides for a two-tier governance system for the company, including the supervisory board, which oversees the strategic issues of the company and is responsible for the establishment and effective functioning of the internal control system, and the executive board — the executive body that manages the daily operations of the company.
The executive board, as the executive body of the company, includes the chairperson and board members who are officers of the company. According to the December 2015 rules of procedure of the company's executive body, the members and chairperson of the executive board are elected by a general meeting on the basis of proposals from the committee on nomination and remuneration of the supervisory board; the first deputy and chairperson's deputies are elected by the executive board from among its members. One person can be elected to the board repeatedly.
FURTHER CORPORATE GOVERNANCE DEVELOPMENT PRIORITIES
Despite the fact that significant improvements were made in 2015 as part of the corporate governance reform plan, implementation of the CGAP in terms of regulatory acts has been slow.
The adoption of the draft laws of Ukraine "On Amendments to Certain Legislative Acts of Ukraine on Improving Corporate Governance of JSC "National Joint Stock Company "Naftogaz of Ukraine", the gas transmission system operator and entities, of which they are shareholders (founder, member) and "On Prevention of Political Meddling in Economic Activity of Oil and Gas Companies" constitute one of the priorities for corporate governance reform that will ensure the irreversibility of the changes. These draft laws are designed to prevent political meddling and graft, cancel ineffective control mechanisms that create obstacles for competitiveness and the development of the company, and aim to transform them into effective and transparent instruments. In particular, it is proposed to change the procedure for financial planning approval, introduce an effective dividend policy, eliminate conflicting rules existing in the legal framework, etc.