VZCZCXYZ0000
RR RUEHWEB

DE RUEHKV #0118/01 0181425
ZNR UUUUU ZZH
R 181425Z JAN 07
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 0935
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCPCIM/CIMS NTDB WASHDC

UNCLAS KYIV 000118 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EB/IFD/OIA (JNHATCHER) AND EUR/UMB 
STATE PLEASE PASS TO USTR FOR KLEIN/MOLNAR 
USDOC FOR 4201/DOC/ITA/MAC/BISNIS 
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYCK 
 
E.O. 12958: N/A 
TAGS: EINV ETRD KTDB OPIC USTR UP
SUBJECT: UKRAINE: 2007 INVESTMENT CLIMATE STATEMENT 
 
REF: A) KYIV 114 
     B) KYIV 113 
     C) 2006 STATE 178303 
 
¶1. Refs A and B contained parts one and two of the 2007 
Investment Climate Statement (ICS) for Ukraine.  The third 
and final part of the ICS is below. 
 
Text Continued: 
 
A.9. Efficient Capital Markets and Portfolio Investment 
 
BANKING 
 
The Ukrainian banking system consists of the National Bank 
of Ukraine and commercial banks.  The NBU is responsible 
for monetary policy, licensing of commercial banks, and 
oversight of their activities. 
 
The banking sector plays a still small, but growing role in 
Ukraine's economy.  Bank capital is just over 8% of GDP. 
Total bank assets in Ukraine are about UAH 310 billion, 
with total loan assets of UAH 238 billion.  Money lending 
and deposits grew at a fast 52% and 27% respectively in 
January-October, 2006. Despite rapid growth, bank deposits 
account for 39% of GDP.  Interest rates continued to 
decline from 16.4% in 2005 to 14.9% in 2006 making credit 
more accessible. On December 1, 2005, the Rada amended the 
"Consumer Rights Protection" law in favor of borrowers that 
lifted the limitation on early loan repayment.  There are 
166 banks operating in Ukraine, but a handful of banks 
dominate the market. The top dozen banks control 61% of the 
loans outstanding and own 42% of the total capital of the 
system.  As the volume of consumer lending more than 
doubled during 2006, the share of loans exceeding one year 
increased to 58% of the total loan portfolio of the banking 
system, up from 53% last year.  Non-performing loans were 
registered at 2% of the total lending portfolio. 
 
In January 2002, the law "On Banks and Banking Activity" 
eliminated discrimination against foreign banks.  It 
entrusted the NBU with issuing banking licenses and 
includes provisions to prevent money laundering.  The NBU 
sets minimum capital requirements each year to be met by 
the banks by the year-end.  Current minimum capital 
requirements range from UAH 20.04 million ($4 million) to 
UAH 133.3 million ($26.3 million). Foreign licensed banks 
may carry out all the same activities as domestic banks and 
there is no ceiling on their participation in the banking 
system.  Foreign banks can operate via subsidiaries in 
Ukraine.  On November 16, 2006 the Rada approved an 
amendment to the law "On Banks and Banking Activity" 
permitting foreign banks to operate via branch offices. 
The law anticipates a transition period of five years and 
sets requirements for branches of foreign banks, including 
cooperation with Financial Action  Task Force and UAH 68.8 
million ($13.6 million or EUR 10 million) minimum capital 
of the branch.  Foreign banks have increased their presence 
in Ukraine's banking sector.  The second largest Ukrainian 
bank, "Aval," was purchased by the Austrian Raiffeisen bank 
in October 2005 and medium-size UkrSibbank by French BNP 
Paribas in December 2005.  In 2006 European financial 
groups purchased an additional 10 Ukrainian banks.  Foreign 
banks now account for approximately 25% of bank capital in 
Ukraine. 
 
In May 2002, most provisions of the law "On Systems of 
Payment and Money Transfer in Ukraine" came into effect, 
making payments more flexible and modern, including the use 
of electronic signatures.  In July 2001, a law "On 
Financial Services and State Regulation of Financial 
Markets in Ukraine" was passed which established legal 
principles for the provision of financial services and 
performance of regulatory and supervisory functions. 
Ukraine remains a cash economy, but the use of credit cards 
is on the rise.  From January through September 2006, the 
use of credit cards increased by 48% and use of ATM cards 
increased over 46%, despite persistent credit card/ATM 
fraud in Ukraine. 
 
INSURANCE 
 
Currently, based on the 1996 law "On Insurance," only 
insurance companies registered in Ukraine may carry out 
insurance operations.  There is a lower minimum capital 
requirement for domestic insurance companies than insurance 
companies with foreign shareholders.  Foreign insurance 
companies can invest in local companies, but to operate 
locally they are required to open branch offices.  In 
November 2006, however, the Rada adopted amendments to the 
law "On Insurance" that give foreign companies the right to 
operate in Ukraine through affiliates five years after 
Ukraine accedes to the WTO. 
 
CAPITAL MARKETS 
 
The legal and regulatory framework, as well as financial 
disclosure systems for the securities market, continues to 
lag behind international standards.  Basic market 
infrastructure exists as does a competent regulator, but 
the legislative basis for capital market operations is 
weak.  Rulings of the Securities and Stock Market State 
Commission (SSMSC) have insufficient enforcement power and 
are not always followed by the courts.  Investors continue 
to face low market confidence, high macroeconomic risk, 
transitional accounting standards, a lack of accurate 
company information, and inadequate protection of minority 
shareholders' rights. Deficiencies in regulations governing 
operation of registrars led to frequent cases of double 
registration of shares, resulting in low protection of 
shareholders' rights. 
 
Ukrainian law allows for the following types of securities: 
-- share securities (shares, investment certificates); 
-- debt securities (bonds of enterprises, state bonds of 
Ukraine, bonds of local loans, treasury obligations of 
Ukraine, savings (depository) certificates, bills of 
exchange); 
-- mortgage securities (mortgage bonds, mortgage 
certificates, mortgages, certificates of funds of 
operations with real estate); 
-- privatization securities; 
-- derivative securities; 
-- title securities 
 
According to the SSMSC, last year there were 139 collective 
investment institutions, 794 securities traders, 143 
custodians, 370 registrars, and 12 self-regulatory 
organizations (six of which are associations). Nine stock 
exchanges were registered in Ukraine.  A Ukrainian 
securities industry broker/dealer self-regulatory 
organization (SRO) and its nationwide electronic trading 
system (PFTS) is the largest stock exchange with about 97% 
of secondary onshore trading.  PFTS Stock Exchange market 
capitalization was UAH 125 billion (USD 25 billion) in 
early 2006.  The Ukrainian government is currently 
considering options to consolidate the remaining, mostly 
dormant stock exchanges to enhance price transparency, and 
improve stock exchanges listing standards to establish 
corporate governance and information disclosure based on 
international norms. 
 
The absence of a central securities depository complicates 
transparent and efficient transfer of ownership records, 
protection of ownership rights and clearance and settlement 
of trades.  Although a 1997 law created a state-owned 
National Depository in 1999 which does not perform 
depository functions, the market-owned MFS Depository has 
been operating commercially as the Ukrainian Depository 
since 1997 in line with current international practice. The 
Ukrainian government is currently considering reform 
options to establish a predominately privately owned 
Ukrainian Central Depository through the merging of two 
institutions. 
 
Principle laws, decrees, and regulations governing 
Ukraine's capital markets include: the law "On Securities 
and Stock Exchanges" (1991), replaced in May of 2006 by the 
law "On Securities and Stock Market' (2006), the law "On 
Business Associations" (1991), "Presidential Decree on 
Investment Funds and Investment Companies" (1994), "Law on 
State Regulation of Securities Markets" (1996), "Amendments 
to Law on Business Associations" (1996),the  law "On 
National Depository System" (1997), "Law on Accounting and 
Financial Reporting" (1999), "Bankruptcy Law" (1992) law 
"On Collective Investment Institutions" (2001), and the 
"Law on Financial Services" (2001). 
 
A law "On Collective Investment Institutions" encourages 
the creation of mutual funds, introduces the idea of a 
licensed asset manager, regulates the establishment and 
operation of subjects of mutual investment, provides 
guarantees of ownership rights to securities, and protects 
rights of exchange market participants.  The Ukrainian law 
"On Circulation of Promissory Notes" (2001) provides a 
framework for the circulation of promissory notes in 
accordance with the Geneva Convention of 1930. 
 
A new law "On Securities and Stock Market" (2006) 
represents a major improvement over the prior law "On 
Securities and Stock Exchanges" (1991), especially on the 
new internationally compliant disclosure requirements for 
listed companies, issues of transparency of ownership, and 
the new rules for insider information and insider trading. 
 
The law "On Business Associations" is vague and does not 
support basic shareholders rights and facilitates a large 
number of corporate governance abuses (including share 
dilution, asset stripping, and dubious transfer pricing). 
The law is widely recognized to be inadequate and in need 
of reform. 
 
Recently, Ukraine has witnessed an escalation in corporate 
hijacking activity.  Hijackers generally take advantage of 
deficient legislation, corrupt courts, and a weak 
regulatory system to gain control of companies at the 
expense of rightful shareholders.  Typically, predatory 
groups of shareholders have been able to secure court 
decisions invalidating or diluting the voting or ownership 
rights of other investors.  Around a dozen such attacks 
occurred during the year, harming investors, including U.S. 
companies and shareholders, and damaging the image of 
Ukraine among foreign investors.  The GOU recognizes the 
seriousness of this problem and has begun to take steps to 
address it.  However, the government has failed to move 
forward quickly with the draft law "On Joint-Stock 
Companies," recognized as a key element to better combat 
corporate hijacking. 
 
A.10. Political Violence 
 
General parliamentary elections took place in March 2006 
without any significant disruptions or violence.  The 
likelihood of future widespread politically inspired 
violence that would affect foreign property interests 
remains relatively low. 
 
A.11.a Corruption 
 
Corruption pervades all levels of society and government 
and all spheres of economic activity in Ukraine and is a 
major obstacle to foreign direct investment.  President 
Yushchenko has made combating corruption a top priority, 
and Ukraine's new government under Prime Minister Viktor 
Yanukovych has affirmed its commitment to anti-corruption 
efforts, although much remains to be accomplished.  Ukraine 
improved on Transparency International's Year 2006 
Corruption Perception Index (CPI), which was published in 
November 2006.  The country moved up to 99th place in 2006 
on the list of the 163 countries from 107th place out of 
158 countries in 2005 and from 122nd place out of 145 
countries in 2004.  In 2006, Transparency International 
rated Ukraine at 2.8 points on the CPI's 10-point scale, an 
improvement over the 2005 rating of 2.6 points. 
 
Corruption stems from a number of factors: a lack of 
institutional traditions of transparent decision-making and 
societal understanding of the importance of corporate 
governance and transparency.  Low public sector salaries 
fuel corruption in local administrative bodies such as the 
highway police and tax administration as well as in the 
education system.  Miniscule salaries in the medical system 
mean that the state guarantee of "free medical care" has 
been largely supplanted by a system of informal payments 
where patients are expected to make extra payments to 
receive treatment.  High-level corruption ranges from 
misuse of government resources and tax evasion to non- 
transparent privatization and procurement procedures.  In 
short, corruption impacts the daily lives of Ukraine's 
citizens and important decisions taken at the state level. 
 
Ukraine's prosecution of corruption is based on the law "On 
Combating Corruption," which was passed in October 1995. 
The law is rarely enforced, and on the rare occasions it is 
enforced, it is normally aimed at lower- or mid-level state 
employees.  In January 2006, the President Yushchenko 
signed a decree requiring Ukraine to honor its obligations 
to the Council of Europe, which include several anti- 
corruption provisions.  In September 2006, the President 
signed a separate decree adopting a national anti- 
corruption strategy that directs all branches of government 
to support these efforts.  In October 2006, the President 
submitted to the Rada a package of draft laws on anti- 
corruption and ratification instruments for the Council of 
Europe Criminal Law Convention on Corruption.  Ukraine in 
2006 adopted a Threshold Country program under the U.S. 
Millennium Challenge Corporation aimed at preventing 
corruption.  This two-year program will provide about $45 
million in assistance to reform the judiciary, reduce 
regulatory problems, institute internal assets declaration 
and inspector generals, enhance civil society monitoring of 
corruption, and reduce corruption in higher education 
admissions through standardized testing. 
 
Although government action is still limited, fundamental 
changes have taken place in the GOU's attitude towards 
corruption.  Gone are the days when GOU officials refused 
to admit that corruption existed in Ukraine.  Government 
and Rada officials now openly discuss the problem of 
corruption with USG contacts and with the press and public 
at large.  In March 2005, Ukraine ratified the Council of 
Europe Civil Law Convention on Corruption and became a 
member of the Council of Europe's Group of States Against 
Corruption (GRECO).  Ukraine has not yet ratified the 
Council of Europe Criminal Law Convention on Corruption, 
signed in January 1999, or the UN Anticorruption 
Convention, signed in December 2003.  Ukraine is not party 
to the OECD Convention on Combating Bribery of Foreign 
Public Officials in International Business Transactions. 
 
RULE OF LAW 
 
As discussed above, improvement of the ability of investors 
to protect their property and contractual rights is crucial 
to the investment climate.  The judicial system needs to be 
reformed and its independence strengthened.  Enforcement of 
court decisions also is lacking. 
 
A.11.b.  Bilateral Investment Agreements 
 
BILATERAL INVESTMENT AGREEMENTS 
 
The Bilateral Investment Treaty between the United States 
and Ukraine came into force on November 16, 1996.  The 
following countries have also signed bilateral investment 
agreements with Ukraine: Albania (2004), Austria (1996), 
Argentina (1995), Armenia (1994), Azerbaijan (1997), 
Belarus (1995), Bulgaria (1994), Brunei (2006), Canada 
(1994), Chile (1995), China (1992), Cuba (1995), Croatia 
(1997), the Czech Republic (1994), Denmark (1992), Egypt 
(1992), Estonia (1995), Finland (1992), France (1994), 
Gambia (2006), Georgia (1995), Germany (1993), Greece 
(1994), Indonesia (1996), Iran (1996), Israel (1995), Italy 
(1993), Hungary (1995), Kazakhstan (1994), Kyrgyzstan 
(1993), Latvia (1997), Lebanon (1996), Lithuania (1994), 
Macedonia (1998), Moldova (1995), Mongolia (1992),  the 
Netherlands (1994), Panama (2005), Poland (1993), Russia 
(1998), Saudi Arabia (2003), Slovakia (1994), Slovenia 
(1999), South Korea (1996), Spain (1998), Sweden (1995), 
Switzerland (1995), Turkmenistan (1998), Turkey (1996), UK 
(1993), Uzbekistan (1993), Vietnam (1994), Yugoslavia 
(2001), Yemen (2002).. 
 
A.11.c.  OPIC and Other Investment Insurance Programs 
 
The U.S.-Ukraine Overseas Private Investment Corporation 
(OPIC) Agreement was signed in Washington on May 6, 1992. 
OPIC halted support for projects in Ukraine in 1999, 
however, after OPIC and the Government failed to reach 
agreement on reimbursement to OPIC for its payment of a 
claim by a U.S. business whose investment had been 
expropriated.  Although OPIC resumed activities in Ukraine, 
based on progress in negotiations, it again suspended 
activities in 2006, but efforts to find a resolution 
continued. 
 
On July 20, 2002 the Board of the U.S. Export-Import bank 
opened facilities for short and medium-term (up to seven 
years) lending for commercial, and sub-sovereign projects. 
Ukraine is a member of the Multilateral Investment 
Guarantee Agency (MIGA).  In 2005 MIGA issued an $18.1 
million guarantee to Raiffeisen Bank of Austria to provide 
coverage against the risks of transfer restriction and 
expropriation its subordinated shareholder loan to Joint 
Stock Commercial Raiffeisen Bank Ukraine. 
 
A.11.d.  Labor 
 
LABOR AVAILABILITY 
 
Ukraine has a well-educated and skilled labor force with 
nearly a 100% literacy rate. The official (registered) 
unemployment level is low, 2.3% as of November 2006, but 
these figures are misleading.  Most experts agree that 
reported unemployment is understated:  the real 
unemployment rate is estimated to be 7.4 %. 
 
WAGES 
 
Wages in Ukraine are very low by Western standards but 
increased significantly over the past year.  In November 
2006, the nominal average monthly wage in Ukraine was UAH 
1073.10 ($214), up 19.7% from UAH 896.58 ($178) in November 
2005 and up 66.6% from UAH 644.27 ($128) in November 2004. 
Real wages grew by 20% between January and October 2006. 
The highest wages are in the financial and aviation sectors 
while the lowest wages were paid to agricultural and public 
health workers. 
 
MINIMUM WAGE 
 
The minimum monthly wage was increased in December 2006 to 
UAH 400 ($80), up from UAH 375 ($75) in 2005.  According to 
Ukrainian legislation, the minimum wage is adjusted 
whenever consumer price increases reach 5%.  The draft 2007 
state budget stipulated further gradual increases of the 
minimum wage to UAH 450 ($90) by the end of 2007. 
 
PENSIONS 
 
On January 1, 2004 Ukraine implemented a comprehensive 
pension reform program, based on international standards, 
which established a three-pillar system: Pillar I, a 
solidarity system, Pillar II, a mandatory accumulation 
system, and Pillar III, a voluntary private pension system. 
The solidarity system, Pillar I, implemented the standard 
under which retirement payouts are determined on the basis 
of the individual's labor records and contributions. 
Despite the major reform, the Pillar I system is complex 
with low retirement ages (60 for men and 55 for woman), 
full retirement benefits based on 20 years of service for 
woman and 25 years for service for men, and many special 
early retirement provisions. 
 
Pillar II, the Mandatory Accumulation System, is to be 
funded by pension contributions made by individuals and 
employers.  However, the 2003 legislation provided that 
Pillar II would be introduced only if the following 
conditions are met: 
 
-- Stable economic growth of at least 2% of GDP per annum 
   for two consecutive years; 
-- The Pension Fund of Ukraine budget is balanced; 
-- The specific legislation for implementation of Pillar II 
   is adopted; and 
-- Experience with the operation of private pension funds. 
 
Currently the conditions for the introduction of Pillar II 
have been met.  The "Draft Law on Implementing the 
Accumulation System of the Mandatory State Pension 
Insurance and Amending Certain Laws of Ukraine" has been 
drafted and it is currently expected that the draft Law 
will be submitted to the Verkhovna Rada in early 2007.  The 
draft Law provides for a gradual phase-in of employee 
contributions starting with 2% in 2009 and increasing by 1% 
per year reaching the maximum 7% provided by the draft Law 
in 2014. 
 
Pillar III, voluntary private pension funds, began actual 
operations in September 2005, following the adoption of the 
required normative acts by the Financial Services Regulator 
in January 2005.  For the last year the development of 
private pension funds is quite positive, showing a 24% 
increase in the last six months. 
 
According to the Financial Services Regulator, Private 
Pension Fund assets have increased by an average 48 percent 
per fiscal quarter, since becoming available in 2005.  In 
Q1 2005, assets under management of Private Pension Funds 
were approximately $2.65 million, by Q2 2006 assets had 
reached approximately $18.75 million, and by Q4 2006 assets 
are projected to reach $41.07 million.  Unfortunately, due 
to the lack of financial instruments in Ukraine, assets of 
private pension funds continue to be invested primarily in 
bank deposits, which do not meet the long-term portfolio 
needs of these funds.  If the situation continues, it can 
easily be argued that private pension funds will not meet 
the payout requirements of future pensioners. 
 
Major impediments for the future development of the pension 
industry in Ukraine include: (i) fiscal imbalances 
resulting from 2004-2005 revisions of Pillar I; (ii) lack 
of quality investments on the Ukrainian capital market that 
need to become available to the pillar II and III; and 
(iii) weaknesses in the regulatory and supervisory 
framework. Also there is an important relationship between 
the development of a pension industry in Ukraine and 
development of the stock market with respect of market 
capitalization and value traded. 
 
LABOR/MANAGEMENT RELATIONS 
 
Ukrainian workers are generally accustomed to "top-down" 
management practices and therefore usually do not 
demonstrate initiative.  A younger, more independent-minded 
generation is slowly moving into the workforce, and it is 
becoming easier to find professional personnel who function 
independently. 
 
Although investors may encounter government resistance to 
trimming the work force to an efficient level, across-the- 
board demands to maintain employment levels are 
disappearing.  Ukrainian enterprises often still maintain 
much of the social infrastructure of their immediate 
community (schools for local children, cafeterias, and 
medical facilities).  While many local officials are 
willing to work with businesses to identify social services 
that an enterprise must support, such arrangements should 
be clearly spelled out before investments are started. 
 
A.11.e.  Foreign Trade Zones/ Free Ports 
 
Until 2005 Ukraine maintained two forms of Special Economic 
Zone (SEZs): 11 Free Economic Zones (FEZs) and 9 Priority 
Development Territories (PDTs).  On March 23 2005, a law 
"On the Amendments to 2005 Budget of Ukraine" cancelled all 
tax privileges (i.e. land tax, corporate income tax, import 
duty, and VAT on imports) to SEZs that had been meant to 
encourage investment and production of goods for export. 
The IMF and the World Bank had repeatedly expressed concern 
about tax evasion and smuggling in the zones, strongly 
supported the elimination of tax exemptions, and urged the 
GOU to resist pressures to reopen the tax loopholes closed 
in the 2005 budget amendments.  In cases of foreign direct 
investment, where the investing firms had met the 
conditions for the privileges, the IMF and the World Bank 
suggested that the GOU determine whether compensation may 
be due to some investors. 
 
The new government of Prime Minister Yanukovych has 
announced its intention to re-establish some tax and 
customs privileges for investors and export processors 
located within SEZs, through draft amendments to the Law of 
Ukraine "On General Principle of Creation and Functioning 
Special Economic Zones," and stated it would develop a 
compensation mechanism for investors who suffered from the 
2005 cancellation.  The GOU states that the main goal of 
this law is to improve the investment climate in Ukraine 
and to launch new, export oriented, innovative projects. 
The draft law provides investors in SEZs with tax 
privileges, including investment (profits) tax credits and 
duty-free imports of equipment.  The GOU asserts that the 
newly constituted SEZs will operate in compliance with WTO 
provisions.  By year's end, no action was taken to re- 
establish the SEZs, and the planned privileges were not 
defined. 
 
FREE PORTS 
 
Porto-Franco FEZ in Odessa Port was a free port until all 
FEZ privileges were cancelled by the 2005 budget.  The 
draft law "On General Principle of Creation and Functioning 
Special Economic Zones" anticipates tax privilege renewal 
for the Odessa Port.  In total, Ukraine has 20 seaports and 
10 river ports located on the Black Sea, the Sea of Azov, 
and the Danube, Yuzhniy Bug, and Dnipro rivers.  They are 
currently under the authority of the Ministry of 
Transportation's Department of Sea and River Transport. 
All seaports are state-owned with the exception of a small 
port that belongs to the Mykolayiv Alumina Plant.  All 
river ports are open or closed joint-stock companies. 
 
A.11.f. Foreign Direct Investment Statistics 
 
FOREIGN DIRECT INVESTMENT 
 
According to Ukraine's State Statistics Committee, as of 
October 2006 the total stock of FDI in Ukraine was $19.9 
billion, or $424 per capita.  This was a 22.3% increase 
from the end of 2005, when the total stock of FDI stood at 
$16.4 billion, or $341 per capita, and a 136% increase from 
January 2005, when FDI was only $8.4 billion.  Mittal 
Steel's October 2005 purchase of the Kryvorizhstal Steel 
Mill represented a major inflow of FDI, at $4.8 billion, 
into Ukraine.  Purchases of Ukrainian banks by European 
banks represented another major inflow of foreign direct 
investment in 2005 and 2006. 
 
FDI BY COUNTRY 
 
As of October 1, 2006 Ukraine's major investors included: 
Germany (28.6% of total FDI), Cyprus (11%), Austria (8.3%), 
the United Kingdom (7.6%), the United States (7%), the 
Netherlands (6.9%), British Virgin Islands (4.0%), and 
Russia (4.6%).  Cyprus is a popular offshore destination 
for Ukrainian and Russian enterprises. 
 
FDI BY INDUSTRY SECTOR DESTINATION 
 
Over the first 9 months of 2006, 10.5% of new FDI went to 
the financial industry, 10.0% -- to domestic trade, 7.2% -- 
to real estate, 6.9 % -- to the metallurgy sector, and 6.2% 
-- to food processing. 
 
End Text. 
 
TAYLOR