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Win-win. How the government, business and local communities can benefit from extractive contract disclosure

03 November 2017231Економічна правда
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Business of extractive companies is associated with high risk due to both the complex nature of the extraction as a production process and the bureaucracy. According to the estimations provided by the Association of Gas Producers of Ukraine, bringing new deposits into commercial production requires approximately 40 permits to be issued by 16 different authorities.

Telling the truth is easy and pleasant

The Master and Margarita, M. Bulgakov

The legwork will take more than three years (nearly 42 months) before the field works actually start.

Such over-regulation does not foster both public and private companies, let alone protection of local communities’ interests, which are usually handled in a rather formalistic way. Recovery of mutual trust among all stakeholders may be achieved only by ensuring transparency and accountability both on the part of the government and companies.

Transparency Triad

Good governance in extractive business builds on comprehensive disclosure standards applicable during the entire value chain. Transparency requires that both the government and companies adhere at least to the following practices:

  • detailed reporting of all payments made in the process of qualifying for extraction and in the course of the business activity;
  • identifying the beneficial owner of extractive company; and
  • disclosure of contractual provisions under which the government grants the right to subsoil use.

 

The first two standards have are of more financial and anticorruption nature, and, as such, their implementation is often covered by the introduction of general requirements to accounting, as well as to instruments of financial intelligence and anti-money laundering policies.

In addition, Directive 2013/50/EU (on transparency) and Directive 2013/34/EU (on financial reports) include relevant rules and are subject to compulsory implementation in Ukraine under the EU-Ukraine Association Agreement. According to those rules the oil, gas and mining, as well as lumber companies must report payments made to the governments at the project level. Pursuant to those Directives the Parliament of Ukraine has already adopted amendments to the Law of Ukraine “On Accounting and Financial Reporting in Ukraine” to be signed by the President, and may adopt the draft law No. 6229 “On Ensuring Transparency in Extractive Industries”; these may be adopted by the Parliament by the end of 2017.

Negotiations on obtaining the right to develop the Yuzivska gas field by Yuzgaz B.V. which refused to disclose its ultimate beneficial owners for a long time, showed that identifying beneficiaries is not an easy task. Nevertheless, Ukraine’s recent efforts aimed at creating the world’s first register of beneficiaries have received special award from the Extractive Industries Transparency Initiative (EITI).

However, both local communities and business climate in general rely mostly on the requirement to disclose the subsoil use licenses.

What do contracts really imply?

Mineral extraction in Ukraine is regulated by various types of contracts, including subsoil use contracts, production sharing agreements and joint operating agreements. Each type includes publicly relevant provisions such as fiscal provisions, environmental safety provisions, and social obligations, including infrastructure investments.

Moreover, sometimes such contracts include so-called stabilization clauses that exempt specific projects from amendments to general framework of laws and regulations. Besides, an important part of any contract with the government is an obligation to recover original state of the allocated field or eliminate consequences of the extraction process. Opting for or neglecting such provisions, as well as the nature of the companies’ obligations are aspects of crucial importance for local communities.

What exactly should be subject to disclosure? Of course, we should speak about complete disclosure, i.e. disclosure of full text of contract with all related documents which in any way impact public interests, i.e. annexes, additions, tables, amendments and certain other related documents such as environmental impact assessment reports.

How do all parties benefit from the contract disclosure?

Naturally, any commercial company would be willing to conceal such sensitive information from both the public at large and their own competitors, especially in countries with poor political governance and high corruption risks. So why do so many of them speak for the greater transparency initiatives?

First, as we already know, the disclosure of contractual provisions is beneficial for communities, which can obtain reliable and true information about actual plans and consequences pertaining to operation of such companies within their territory. Thus, complaints — either reasoned or not — upon social and economic problems associated with the activities of extractive companies in their territory from the mere assumptions based on scarce information turn into a dialogue between informed and equal partners where everyone can defend its interests. Fair playing companies are indeed interested in getting social licence to operate from the communities and to establish a dialogue without unjustified accusations.

Moreover, often things which begin with cheerful signing of documents at the top level turn into expropriation, nationalization or other government`s violations of the legitimate rights and interests of investors. Similarly, such risks are more peculiar to countries where the rule of law has no real observation. Preserving confidentiality of the essential provisions of contracts prevents the extractive companies from relying upon additional remedies such as civil control over the government and public pressure.

Another important aspect is commitment to principles of transparency as the best practice of public governance. Following the global financial crisis in 2008–2009, global institutions such as the World Bank group have initiated and advocate high standards of business ethics via projects such as GIFT (Global Initiative for Financial Transparency) and OCDS (Open Contracting Data Standard). Further development in this area will result in a situation where an extractive company will not be able to receive funding from esteemed creditors unless it proves that its plans are trustworthy.

Finally, contracts disclosure remains a powerful facilitation for a better business environment within the extractive industries. Obviously, in dealing with the government representing a fair, open and predictable partner who insists on publicity of all arrangements, any global extractive major would know a (comparatively) small amount of funds as a bribe will not be helpful in gaining a certain privilege; however, this will be true for their competitors as well.

Practical implications

As of 2017, there have been as many as 39 countries, which disclose texts of their signed contracts for using the subsoil or parts thereof, 27 of which have adopted such requirements at the legislative level. The Extractive Industries Transparency Initiative (EITI), most sophisticated complex of recommendations and rules on transparency in extractive business (to which Ukraine joined in 2013), merely encourages countries to introduce contract disclosure practices and does not require it from its members. However, voluntary undertaking of such commitments is highly valued by the IMF, UN, EBRD and is indicated among requirements for applicant companies by IFC, a part to World Bank Group.

Unfortunately, no obligations have been established in Ukraine requiring disclosure of provisions of the subsoil licences. Negotiating of such provisions is also covered with the mystery. Moreover, should the text of contract be made public by some occasion, one can never be sure whether there are amendments or addenda or the entire text has been redrafted.

The Resource Governance Index tracks and evaluates the quality of resource governance in the oil, gas and mining industries in 81 countries. According to that Index, the important quality aspects of the licensing process include contract disclosure obligations and respective practices. Although the 2017 Resource Governance Index for Ukraine suggests a rather positive estimation of the licensing process (74 points out of 100), contract disclosure is the only indicator scored at zero due to lack of relevant rules.

So what can be done for Ukraine to join the cohort of the countries committed to the best practices in the field of extractive industry transparency? The EITI standard contains detailed recommendations and necessary steps to be made on this difficult way. Based upon these guidelines, a group of MPs, the EITI Secretariat in Ukraine and civil experts have developed the draft law No. 6229 “On Ensuring Transparency of Extractive Industries” which gained support from the responsible Committee and is pending the first reading in the Parliament of Ukraine.

The document provides for disclosure of essential provisions of contracts for subsoil use along with the relevant excerpts from such contracts. In addition to merely formal elements (parties, date of entry into force and duration, subject matter), the disclosure requirement must apply to information about the rights and obligations of the parties, payment procedures, specific commitments within the work programme and the environmental safety measures, labour safety requirements, as well as social obligations to local communities.

Once the draft law is adopted and enters into force, the government should issue a specific resolution on the procedure for disclosure of such information by economic operators engaged in extractive industries.


Author: Денис Назаренко
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