The state is expected to play an active role in improving Ukraine's chances for more investment

Ukraine's economic recovery is a massive challenge on a scale that the world has not faced since the Marshall Plan. Based on similarly relevant examples, international aid typically accounts for about 50% of a country's budget in the first 5–10 years of recovery. However, the amount of recovery aid is not necessarily related to the success or failure of further economic development. What does have a direct impact is a systematic focus on the development and participation of private business in said recovery, as was the case with Croatia's integration into the EU and South Korea after 1961.

Increased private investment is needed to combat unemployment, population outflows, and a potential “brain drain” of talent. The public sector depends on international aid which is bound to decrease, and this certainty will shock the country when it happens. The natural magic pill is private foreign investment. From a regulatory perspective, what will determine Ukraine's chances of welcoming international investors soon?

Movement towards the Eurozone.

Moving towards and joining the EU is a powerful anchor for our economy. This defines many directions for reconstruction, such as new comprehensive regulation according to European standards, compliance procedures, and a coherent sanctions policy. Integration into the global economy dramatically impacts the speed of recovery and economic development (as seen with Croatia and the EU, Korea's transition to an export oriented economy, and the effect of sanctions being lifted on Iraq, to give just a few examples).

Obviously, this sets a decades-long vector for Ukraine. For investors, this means clear regulatory standards and a more understandable matrix for assessing investment opportunities. Starting in 2024, Ukraine will officially launch accession negotiations. In practical terms, this means that the results of the European Commission's report on Ukraine's progress within the EU enlargement package will be considered, and an action plan will be developed to implement the report's recommendations. A national programme will be created to adapt legislation to EU law, known as the "acquis". The development and implementation of the acquis is a monumental task, the full scope of which will be determined by the results of the European Commission's "screening", which is yet to be conducted. However, self-screening undertaken in 2023 has already shown that about 5,000 laws will need to be amended to align our legislation with EU directives. For example, the pharmaceuticals sector will require aligning with 71 EU laws, and the healthcare sector will need 16 EU directives and regulations to be implemented into Ukrainian legislation to bring them into compliance with EU standards. 

The energy sector, which has demonstrated extraordinary resilience in the face of unprecedented destruction caused by Russia's missile terror, is already one of the most legislatively aligned with EU law, falling within the “good level of preparation” grade as defined by the European Commission. However, energy faces many challenging tasks, including adopting the National Energy and Climate Plan (NECP). All EU countries adopt such documents to achieve the goals of the Energy Union as part of the Clean Energy Package for all Europeans. 

A separate but equally major challenge in implementing the acquis is environmental protection, which requires significant changes in Ukraine's legislation and governance model. The results of the "self-screening" showed that out of 1,630 EU laws, 956 have no analogues in our legislation. Specifically, almost 200 essential EU laws in the negotiated Chapter 27 of the accession agreement, Environment and Climate Change, are still to be fully or partially implemented. 

Finally, the Ukrainian steel industry presents an interesting example of the need for complete modernisation to meet new standards. The steel industry has suffered a significant setback due to the destruction of Azovstal and Ilyich Iron and Steel Works in Mariupol. However, there is a “but” to this story. These plants had been built in the golden age of the Ukrainian SSR, and they were already outdated in terms of industrial standards before the full-scale War. This was particularly notable of environmental requirements, especially when compared to their European competitors. Modernisation of the steel industry in Ukraine to meet European standards would have previously required an estimated USD6.6 billion. In terms of time, it was estimated that it would take Ukraine another 30 years to catch up with European technology that has already been in place for 15 years. Despite the unfortunate circumstances, some of these issues have now been alleviated.

 Investment security. 

Businesswise, Ukraine needs to offer investors something more than courage. If the security situation is worse than in other potential investment destinations, Ukraine should have a quick, inexpensive, and effective mechanism to mitigate political and military risks. Relevant similar tools exist both at the intergovernmental level (i.e. MIGA: the Multilateral Investment Guarantee Agency, a UN institution that is part of the World Bank Group) and at the national level of investor countries (COFACE in France, the Export Credits Guarantee Department in the UK, etc.) Each organisation has its own limitations: MIGA cannot offer the volumes and velocity required by Ukraine, while export agencies from investors’ countries each have their specific terms and requirements for insuring investments. 

So far, in 2023, Ukraine had the first successful case of working with MIGA the insurance granted for the M10 Lviv Industrial Park project, an endeavour involving Dragon Capital and the EBRD as partners. The risks covered by this insurance are directly related to the War; namely, physical destruction of the facility as a result of hostile shelling and loss of physical control. International financial institutions, such as the EBRD and DFC, have yet to develop their own mechanisms for Ukraine to insure their products. There have been commitments to create individual mechanisms, but these options are likely to be unavailable for investors seeking other sources of financing outside of these specific agencies. 

However, there have also been positive changes at the national level. At the end of 2023, Ukraine adopted Law No. 9015, granting the Export Credit Agency (ECA) the right to insure Ukrainian and foreign investors against war risks. The law came into effect on 1 January 2024, but legislative work is still pending to classify risks and define the terms and conditions for risk insurance and reinsurance. Ukrainian government officials have acknowledged that the state budget should contribute to the authorised capital of the ECA or enlist the assistance of international donors in order to facilitate the agency's effective operation. As such, the decision has an undeniably positive aspect as it would provide access to insurance to both foreign investors and Ukrainian businesses. 

It is a reasonable expectation that a relatively inexpensive and, most importantly, well-timed solution for ensuring war risks will have a positive impact on investors' willingness to consider Ukraine. Depending on the industry, region, and amount of investment, this will hopefully encourage investors to at least consider the risks affecting a Ukrainian project to be somewhat comparable with a project in a country that is not in a military conflict. The business community also suggests that coverage of up to 100% of losses is not indisputably necessary, as the positive effect of insurance starts at approximately 50% coverage (again, depending on the region, type of assets, amount of investment, investor's risk tolerance, and other factors taken on a case-by-case basis). Relatively speaking, this 50% threshold allows a particular category of investors to assess the risk of a region differently. 

Typically, such insurance covers physical loss of property and investments, while recovery of lost profits is not evident and unconditional. Ukrainian businesses are therefore looking forward to the ECA introducing a classification of the risks that are to be insured against as soon as possible, as well as definitions of its other terms.

The regulatory landscape today.

The current wartime regulations in Ukraine include restrictions on capital withdrawal and new sanctions regulations. A special regime that controls foreign direct investment may potentially be introduced in the future. Restrictions on capital outflows imposed by the National Bank of Ukraine at the beginning of the full-scale War are expected to be eased in 2024. This process will continue what was kicked off by the abolition of the fixed exchange rate in October 2023. The possibility of partial capital withdrawal is currently being discussed, depending on the size of new investments. 

Furthermore, the repayment of new (past-war) loans is generally permitted as long as they meet the certain conditions (specified interest rate, term of repayment). Sanctions regulations are a relatively new legal tool for Ukraine. On the one hand, the nationalisation of sanctioned assets potentially expands the list of good assets to offer to investors. However, on the other hand, the good title to such assets is a critical risk area that a potential acquirer will want to scrutinize. Ukraine is just getting on track when it comes to dealing with complaints from former owners of such assets in the investment arbitration disputes against Ukraine. As these procedures normally take years, we are yet to see the first results of these precedent-setting cases starting from 2025.

Finally, the polarity of the world naturally pushes Ukraine to discuss the introduction of a so-called FDI (foreign direct investment) regime. These rules provide for specific permission procedures for foreign investment to Ukraine, depending on the industry, size, and other investor parameters. More than 100 countries around the world have such rules in various shapes and forms. Ukraine's defence industry may become the first in the line for this novelty as it is subject to strict control when it comes to granting investor access to security data. It is clear that the state is now expected to play a very active role in improving Ukraine's chances of attracting more investment. This includes improving the overall investment climate as much as realistically possible in a wartime environment, creating and supporting special international and intergovernmental programmes to help Ukrainian companies raise capital from IFIs, providing political and diplomatic support for significant private funds and strategic investors, and the launch of an investment insurance programme.

Source - M&A Radar 2023: Ukraine | Market analysis - KPMG Ukraine