UKRAINE: POLITICAL CLASH HIGHLIGHTS CORRUPTION IN

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001862

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STATE FOR EUR/UMB
TREASURY FOR ALIKONIS
STATE PLEASE PASS TO USTR FOR CKLEIN/LMOLNAR
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USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK

E.O. 12958: DECL: 07/31/2017
TAGS: EIND EFIN EINV PGOV UP
SUBJECT: UKRAINE: POLITICAL CLASH HIGHLIGHTS CORRUPTION IN
GOVERNMENT PROCUREMENT

Classified By: ECONOMIC COUNSELOR DOUGLAS KRAMER, REASONS 1.4 B) AND D)


1. (SBU) Summary: The GOU attempted to push through a
controversial amendment to the government procurement law,
causing indignation among political opponents and spurring
claims that the Party of Regions was trying to grab public
funds for their election coffers. Opposition by President
Viktor Yushchenko, along with a court ruling against the GOU,
appears to have blocked the amendment from taking effect.
The story illustrates the sad state of Ukraine's procurement
law and the corruption endemic to the system. Amendments to
the procurement law in 2006-2007 actually made matters worse,
introducing murky supervision, nontransparent special
requirements, and sectoral exemptions. Foreign companies
have little opportunity to compete for GOU tenders on an
equal footing. Ukraine has committed to cleaning up its
government procurement system in line with WTO rules, but
thus far President Yushchenko appears to be the only major
actor pushing for reform. End Summary.

Contentious Procurement Law
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2. (U) On June 19, the Rada (parliament) approved a
controversial bill that excluded all state-owned enterprises
from requirements to follow government procurement rules,
such as the announcements of open tenders. The law also
stipulated an increase in the threshold requiring government
procurement to be performed via open tenders (from US$10,000
to $20,000 for goods and services, from $80,000 to $120,000
for works). Because the law was passed after President
Viktor Yushchenko's decrees dissolving the Rada, the
President refused to recognize the legitimacy of the law and
never signed it into force. First Deputy Prime Minister
Mykola Azarov announced on July 5 that the GOU intended to
implement the law regardless. (Note: If the Cabinet were to
implement this law, it will be the first passed by the rump
Rada that the Cabinet had chosen to move forward on. End
note.) A Kyiv Commercial Court ruling on July 6 banned
official publication of the law, however. Two heavyweight
politicians and high-ranking officials of the Tender Chamber
-- Raisa Bohatyreva, leader of the Party of Regions Rada
faction and honorary President of the Chamber, and Ksenia
Lyapina, Our Ukraine MP and Vice President of the Chamber --
resigned from the Chamber in protest of Azarov's move.


3. (U) President Yushchenko responded on July 12 by issuing a
decree aimed at managing procurement funds until the new Rada
is in session. The President, through the National Security
and Defense Council, requested law enforcement agencies to
audit state-owned enterprises to ensure adherence to the
current law and proper use of government awards. The
agencies must submit a report on the results of the
investigation to Yushchenko by September 1. (Note: Post has
heard anecdotal evidence that in fact some state-owned
companies (in this case a subsidiary of the state-owned oil
and gas company NaftoHaz) have not been following
requirements for open tenders.)

Illegal Campaign Finance?
--------------


4. (SBU) Several press reports speculated that the GOU was
pushing this new procurement law in order to enable state
funding to be diverted to political campaigns of parties
loyal to the government in the upcoming election. Lyapina
reminded Econoff in a meeting on July 18 that Ukraine had a
precedent for such a scheme, as the Party of Regions had
diverted funds from state-owned NaftoHaz to fund its 2004
electoral campaign. The man behind that scheme, noted
Lyapina, was none other than Azarov, making Azarov's motives
in pushing this recent law very suspicious.


5. (C) In a July 27 meeting, Bohatyreva told Ambassador that
the government procurement process was nontransparent and
corrupt. She had tried to put an end to some of the corrupt
schemes, she maintained, which brought her into conflict with
a number of ministers. First Labor Minister Papiyev promoted
one tender involving disabled people, which Bohatyreva had
squashed. Then she had problems with EnergoAtom Head
Derkach, Energy Minister Boyko, and Health Minister Haidayiv,
all of whom she placed in Azarov and Klyuyev's circle. She
said Azarov pushed for control of the Tender Chamber, and she
was threatened and subsequently told to resign for the good

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of the party. Moreover, she was in Vienna for medical
consultations when statements attacking Azarov were leaked in
her name. Bohatyreva argued that the nontransparent
procedures would continue regardless of who ran the Tender
Chamber, but with her out of the chamber compromising
materials about ministers might now be made public.

How the System Operates
--------------


6. (U) The law "On Procurement of Goods, Works, and Services
for Public Funds" of February 22, 2000 established a single
government procurement system. According to the law,
subjected to a succession of amendments, all government
procurement of goods and services (if valued at more than
$10,000) and works (if more than $80,000) must be contracted
via tenders (either open, or open with pre-qualification).
According to Paul Bermingham, World Bank Director for
Ukraine, Belarus and Moldova, Ukraine's procurement law
largely complied with international standards until
questionable amendments were made in 2006-2007. March 2006
amendments to the law "On Procurement" complicated the
institutional framework, assigned overlapping tasks of
monitoring public procurement to several bodies, and created
rules that encourage conflict of interest. President
Yushchenko initially vetoed this bill, but the Rada mustered
enough votes to override.


7. (U) The Department of Coordination of State Procurement
under the Ministry of Economy had been responsible for
overseeing the procurement system until March 2006. The
system was notoriously corrupt under the Ministry of
Economy's oversight, and this authority was transferred to
the Anti-Monopoly Committee. The Anti-Monopoly Committee is
a strange choice for regulating government procurement,
however, as it does not have particular competence in this
area. The Netherlands is the only other country with such a
practice.

Tender Chamber - NGO with Governmental Functions
-------------- ---


8. (SBU) The 2006 amendments also established the Tender
Chamber, an NGO, as a major player in the procurement
process. The Tender Chamber became responsible for
maintaining a catalogue of bidders, monitoring transparency,
and assuring fairness. Transferring governmental functions
to the private sector generated more negligence in the
administration of public money. For example, the Tender
Chamber maintains a UAH 7000 ($1400) obligatory fee that
bidders are forced to pay in order to be registered in the
catalogue, in conflict with the international practice of
free listing for all interested bidders. Lyapina told
Econoff that, even as the Tender Chamber's Vice President,
she was unable to determine how the decision to introduce
this fee was taken.


9. (C) The Tender Chamber's membership includes not only
governmental and parliamentary representatives, but also
private sector associates. Press reports have often claimed
that this situation creates conflict of interests since some
of the Chamber members exploit their positions financially
and informatively. Lyapina told Econoff that intermediaries
had begun to control access by potential bidders to the
Chamber. Of course, these intermediaries were charging fees
for their "services," thus expanding the scope of corruption.
(Comment: If practice in other areas is any guide, we
suspect intermediaries in turn may have been kicking back
part of their fees to members of the Tender Chamber.)

Murky Supervision and Special Requirements
--------------


10. (U) The March 2006 amendments scattered policy and
oversight functions across several bodies, including the
Anti-Monopoly Committee, the Accounting Chamber (a supreme
audit body, reporting to the Rada),the State Control and
Audit Unit (a body for internal audit, under the Ministry of
Finance),and the Tender Chamber. Experts argue that such
fragmentation prevents the bodies from implementing effective
and sound policy and contributes to a lack of transparency in
the decision making process.


11. (U) The March 2006 provisions also introduced special

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security requirements for websites in order to be eligible
for tender announcements. In May 2006, the Security Service
of Ukraine (SBU) issued its conclusion that none of the
proposed internet sites complied with the safety measures.
Subsequently, however, the SBU allowed the European
Consulting Agency, a Ukrainian private enterprise with links
to the Tender Chamber, to operate a temporary website
announcing the tenders. The European Consulting Agency
continues to this day to operate a monopoly over tender
announcements.

Sectoral Carve-Outs
--------------


12. (U) The March 2007 amendments created a legion of special
public sectors, such as defense, postal and
telecommunications services, and railways, for which
procurement rules do not apply. While international norms do
allow strategically important areas like national defense to
be excluded from the general procurement rules, Ukraine's
practice of "sectoral preference" is likely problematic in
terms of compliance with international standards.

Foreigners Left Out
--------------


13. (U) The law "On Procurement" does not restrict foreign
enterprises from participating in government procurement. In
practice, however, foreign companies are rarely able to
compete on an equal footing. Unclear rules and requirements,
secret wheeling and dealing, and corruption result in a low

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level of participation by foreign companies. According to
the Anti-Monopoly Committee, foreign companies won tenders
for only 0.01 percent of government procurement during the
first six months of 2006.

Moving Toward the WTO
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14. (SBU) Ukraine is not currently a signatory to the WTO
Agreement on Government Procurement (AGP),but will become an
observer to the AGP at the time of WTO accession (expected
within 6-12 months),and has promised to begin negotiations
to accede to the AGP after then. On December 11, 2006 the
WTO Government Procurement Committee, which oversees the GPA,
presented a roadmap for Ukraine's accession to the agreement.
President Yushchenko has tasked Valery Pyatnytskiy, Deputy
Minister of Economy and Ukraine's lead WTO negotiator, to
prepare a WTO-consistent draft law on procurement by
September 15, 2007. A USAID-funded project is working with
the Ministry of Economy on this draft law.

Comment: A Web of Corruption
--------------


15. (C) Public procurement cuts to the heart of governmental
corruption, and Ukraine's track record in this area is not
encouraging. Since independence, Ukrainian officials have
used procurement rackets and kickbacks from state-owned
companies as a handy way to line their pockets. Observers
often cite NaftoHaz as a prime example of this kind of
widespread procurement corruption. That the procurement
process has gotten worse in recent years is of particular
concern. The recent political infighting over amendments to
the procurement law served to expose just how many layers of
corrupt activity exist. Azarov's move to exempt state-owned
enterprises from procurement rules, ironically, would
actually bring Ukrainian practice more in line with WTO
rules. However, the vehemence with which he attempted to ram
through this change made us suspicious that truly substantial
amounts of money were at stake; we strongly suspect Azarov's
motive was likely to make it easier to pilfer from the
companies' budgets. Azarov faced resistance from a leader
within his own party (Bohatyreva) and the opposition
(Lyapina),yet it is hard to believe their motives were any
more principled. As members of the Tender Chamber, it is
logical they would have shared in the apparent flow of
kickbacks, although we have no hard evidence to this effect.
It seems that in Ukraine, corruption is one trait that
crosses party lines.
Taylor