Separation of ownership and regulation

The third core corporate governance feature to be reviewed concerns establishing effective separation of the government’s role as an owner of state-owned companies and the government’s role as regulator, particularly with regard to market regulation.

Exercising ownership rights over SOEs

Estonia follows a decentralised sector ministry model of ownership, although with some central co-ordination by the Ministry of Finance. The State participates in companies generally where a market distortion occurs or where there is a strategic public interest involved. With respect to foundations, the Estonian State operates through a foundation when the state’s objective is more specific (generally for social, cultural or educational purposes or to promote entrepreneurship), and the form of company or government unit is not suitable.

The Ministry of Finance plays a unifying role, as it nominates or designates at least half of all board members in fully state-controlled SOEs (and all board members in the two SOEs where the MoF has the lead ownership interest24). The Ministry also contains a small unit whose duties include the design of overall ownership policy principles of SOEs.

In a critical report by the National Audit Office on “Owner supervision in public undertakings and foundations” published in 2007, one of the key findings was that there “exists no single, agreed and disclosed holding policy”. The NAO argued that it was unclear why the State participated in companies and what its goals as an owner were. This same conclusion is presented in relation to foundations, whose reason for being established, according to the conclusions of the reports is at best unclear.

The Ministry of Finance disagreed with this conclusion, stating that shareholding ministries are obliged to submit a yearly report on the administration of the state’s holdings in which they must state their objectives and “whether the state’s participation in each of its SOEs is still needed/justified or not”. The MoF compiles annually the “Consolidated Report on State Owned Enterprises, Foundations and Non-profit Institutions” which contains for each of these entities a section on the “position on retaining state share”. Generally, there are three main purposes for the state to participate in SOEs which should be referenced in explaining the state’s ownership objectives, according to the Ministry of Finance: 1) optimisation of income; 2) it involves a big natural monopoly which is not yet sufficiently regulated by legislation or the market regulation is too weak to privatise; and 3) the SOE performs/offers mainly public services.

For the consolidated report, compiled by the Ministry of Finance, line ministries submit the annual reports on the performance of the SOEs they administer. The requirements for the content of these reports are set in the law. The Government first discusses and decides on the consolidated annual report and then the report is submitted to the Parliament where it is usually discussed in the Economic Affairs Committee, and to the National Audit Office.

The review team received a translated version of the 2007 consolidated annual report submitted to Parliament by the Ministry of Finance, in which different shareholding ministries reported on their rationale for maintaining certain SOEs in state hands. This document provided varying clarity on the ownership objectives of the shareholding ministries. For instance in the case of state-owned AS Levira (TV and radio broadcaster), the Ministry of Economic Affairs and Communications (as the ownership holding ministry) is referred to as stating that it “finds it necessary to maintain state participation” in this SOE, but according to the MoF, “no specific objectives have been added” (to the report submitted to MoF). MoF provides its own institutional opinion on this issue, stating that “MOF is of the opinion that the primary objective for state participation in the company is earning profit and the secondary objective is providing with indiscriminate and equal conditions ensuring service for all broadcasting firms ... [but that] still it should be analysed whether state participation is essential for achieving this objective” or whether “it might be rational to dispose state share”. MoF states a rationale for keeping or not each of the SOEs in state hands (not only the SOEs for which it holds ownership rights). In the case of the postal service, it questions whether it is rational to keep the entirety of the service in state hands. In the case of Eesti Raudtee, it concludes that the selling off of the cargo function of this operation should be considered. With Tallinna Sadam (Tallinn port), MoF suggests exploring ways to share risks (of large planned investments) by involving other shareholders. In a number of cases MoF suggests that state participation “should be analysed”. While the consolidated report provides a specific opportunity for the Parliament to take stock of the Government’s state ownership objectives, consideration of these issues is ongoing, as evidenced by the Government’s recent decision to sell its remaining shares in Eesti Telekom.

The NAO report also questioned the usefulness of having Ministry of Finance- appointed board members in SOEs where this Ministry does not hold ownership rights, stating that the “sole responsibility for the prudent management of State companies belongs to the Minister engaged in the administration of the holding”. However, the OECD Guidelines suggest that an entity responsible for overall co-ordination of policy can be effective both in ensuring a clear and consistent ownership policy across the government, and in helping to ensure that board members possess complementary skills and experiences that do not serve uniquely the interest of a specific shareholder but the company’s interest as a whole.

NAO recommendations generally were implemented by the MoF. There were, however, three recommendations that were not “fully implemented”, regarding the following issues:

  • Impose a duty on the Minister of Finance to appoint at least one financial specialist as a member of the Supervisory Board - Regarding this recommendation MOF believed that “state representatives may be national officials and other qualified persons who possess the knowledge and experience required to perform their duties”. Consideration needs to be given.... “also [to] the composition of the supervisory board so that all possible spheres of experiences would be represented in the supervisory board”.
  • Establish the duties of the Supervisory Board in performing supervision and provide the Minister of Finance with provision delegating authority to specify said duties - The Ministry of Finance believes that “concrete procedures have to be established by the supervisory boards and therefore the State Assets Act includes the obligation to the supervisory board to establish a charter with clear working principles”.
  • Make the establishment of an audit committee voluntary - Smaller SOEs are no longer obliged to have an audit committee, only larger SOE (according to the Auditing Act).

Guideline I.A calls for a clear separation between the state’s ownership function and other state functions, particularly with regard to market regulation. The separation of the state’s ownership function and other state functions, particularly market regulation, is established through a number of separate regulatory institutions, notably through the Estonian Competition Authority and the Estonian Technical Surveillance Authority. The Estonian Competition Authority executes supervision in the field of competition seeking to ensure a level playing field in those sectors where there is competition. The Technical Surveillance Authority is tasked with supervision in the field of electronic communication, broadcasting frequency management, digital signatures certification services, allocation of railway infrastructure capacity, among others. The SOE questionnaire also mentions a third market regulator whose responsibilities include the issuance of gambling and lottery licences and the supervision of lotteries and gambling. The FSA also oversees Estonia’s only remaining SOE currently listed on the Tallinn Stock Exchange, Tallinna Vesi, a municipally-owned water company.

According to supplementary information provided by Estonia, “the Competition Authority is independent in its decisions, which are made according to the legislation. If a government agency is of a different opinion, it can explain its views to the Competition

Authority” but the latter has the right to ignore these views. The courts will be involved only when an enterprise or SOE does not agree with the Competition Authority’s decision and disputes it. Estonia has a three-level court system - the third level decision is final.

These market regulators are required to follow general principles established by laws and regulations, which are applicable to all enterprises in the same manner regardless of ownership structure.

Although market participants have not questioned the independence of the head of the competition authority, this post is appointed by the Minister of Economic Affairs and Communications and can be removed with good cause. Nevertheless, the most recent head of the Competition Authority has been in place for 15 years, and the removal option has not been exercised.

Furthermore, certain units within Ministries also carry out regulatory functions. The Ministry of Economic Affairs and Communications is configured in such a way as to structurally separate the functions of policy development, strategic planning in the short- and long-term, and that of supervisor/regulator. Ministry officials working in the supervisory branch of the ministry are barred from sitting on boards of SOEs in the same area of activity.

Guideline I.B stresses the need for governments to simplify and streamline the operational practices and the legal form under which SOEs operate. One of the results from this is to “allow creditors to press their claims and to initiate insolvency procedures”. No SOE is protected from bankruptcy of insolvency procedures.

State-owned companies in Estonia can take four distinct legal forms: public limited company (for listed SOEs), private limited company, foundation and profit-making State agency. Most SOEs fall in the first three categories. The fourth form, the profit-making State Agency, is used for only one entity, the Forest Management Centre. This enterprise has a dual role, earning income for the State by logging and selling wood (through auction), and also undertaking non-income generating activities such as the maintenance of forests and creation of free recreational areas.

The management and governance principles of the for-profit state agency, the State Forest Management Centre, were established to mirror those used in private legal entities. It has similar disclosure requirements as private companies. For instance it is required to report quarterly on the financial situation of the centre to its supervisory board (the Commercial Code requires that companies report to their supervisory board after every four months) and also to the Ministry of Finance. Similarly to private companies, an external auditor audits their annual accounts.

When the Forest Management Centre was created, the Ministry of Finance and the Ministry of Environment reportedly disagreed on the type of entity it should be. The Ministry of Finance believed that it should adopt the common form of an SOE. The Ministry of Environment, which holds founder rights, was of the opinion that creating a for-profit state agency would enhance its control over the direction of the Centre. This control can be seen through the more political-level composition of the Centre’s board of directors, which includes several high-level government and parliamentary officials, including the Chancellor/Secretary General of the Ministry of the Environment.25 The issue of whether this runs counter to the OECD Guidelines recommendations against political intervention in the day-to-day operations and regulatory oversight of the company depends on whether the Centre is seen as primarily a commercially-oriented enterprise, or one whose primary purpose is to meet public service objectives. In adopting a special legal form for the Centre, the Estonian government took the position that the Centre had a special public purpose - forest sustainability and management of recreational areas - that despite its “profitmaking” status, was not primarily commercial in nature and required more intensive oversight at political level. According to supplementary information provided for the review, the “for-profit state agency” form was chosen to “utilise the best characteristics of an enterprise” and at the same time retain “direct ownership and control of the state forests”.

As described in the annotations for this particular Guideline, the adoption of a special legal form should not be an obstacle for creditors to press their claims and initiate insolvency procedures. Indeed, for Estonia’s 36 SOEs, no such obstacles are in place. However, the State Forest Management Centre is immune from bankruptcy, as it is not a separate legal person, and is considered to be legally a part of the State, despite the fact that there are no explicit guarantees in the legal acts.

One foundation enjoys an explicit government guarantee on loans. The Credit and Export Guarantee Fund KredEx is a foundation which aims to promote the financing of small enterprises in Estonia, decrease export-related credit risks, enable people to build or renovate their homes, and promote energy efficiency in Estonia. The questionnaire reports that only when the fund’s resources are depleted does the State guarantee loans.

The annotations to Guideline I.B also advise to be mindful of how special legal forms can have an impact on employee remuneration, or give specific pension rights and protection against redundancies to employees of state-owned enterprises. All officials interviewed concurred that there are no specific provisions for SOE or foundation employees. All employment terms are similar to privately-owned companies; the only potential difference is the result of specific collective agreements, which can be reached in any company regardless of ownership composition.

Guideline I.C states that “Any obligations and responsibilities that an SOE is required to undertake in terms of public services beyond the generally accepted norm should be clearly mandated by laws and regulations ... [and] ... should ... be disclosed and funded in a transparent manner”.

Estonia is covered by EC rules on state aid, so state aid can be granted only if authorised by the European Commission or if it is otherwise compatible with EC rules. Where direct State subsidies exist, these are shown in the State’s budget. All companies that receive state subsidies have to keep separate accounts for state subsidies and publish them separately in their annual accounts.

The questionnaire response on SOE governance submitted by Estonia states that the state does subsidise certain SOEs to ensure specific services are delivered “as a deviation from normal commercial practice” in those case where an SOE is not able to offer products or services for which its costs are entirely covered with revenues from its clients, and to achieve certain policy (i.e. structural policy) objectives. Such cases are rare, however.

For example, the state subsidised home delivery of newspapers in rural areas, to harmonise the respective fees with the urban areas, by paying to an SOE - AS Eesti Post (Estonian Post Ltd.) a subsidy (around EUR 1 million annually) which is intended to be used only for this purpose. An additional example of the state paying a subsidy to an SOE AS can be found in the case of Tallinna Lennujaam (Tallinn Airport Ltd.), which receives a subsidy to cover running costs of regional small airports that are managed by the SOE.

Similarly, the questionnaire response states that SOEs can also receive investment subsidies when a certain investment includes the public interest and it would not be profitable without state subsidies. For instance the state pays investment subsidies to AS Saarte Liinid (Saarte Liinid Ltd) for the reconstruction of small regional ports to ensure connection between Estonian islands and the mainland. Nevertheless, this practice is not widespread and appears to be transparently disclosed.

Guideline I.D calls for SOEs not to be exempt from the general application of laws. In addition to this, it stresses the importance of access to efficient redress and even-handed ruling towards all stakeholders, including competitors.

As mentioned above, SOEs are subject to commercial laws in the same way as private companies. Estonia’s response states that a stakeholder whose interests have been violated can claim indemnification through the court system. The review team was not made aware of any cases of stakeholders having resorted to courts in order to settle disputes with an SOE.

Guideline I.F suggests that SOEs should face competitive conditions regarding access to finance. SOE access to state-sponsored financing can be a particular concern, if state- owned banks are providing preferential funding. Their relations with state-owned banks should be based purely on commercial grounds.

In Estonia there are no state-owned banks, but the Ministry of Finance has provided loans and loan guarantees in a few exceptional cases. These loans were provided at commercial market rates, as required under EU law. Loan guarantees have included a requirement that the SOE pay a fee back to the Ministry of Finance to compensate for the extra risk assumed by the Ministry in providing the guarantee. Apart from these exceptions, the main creditors of Estonian SOEs are local commercial banks, international banks and international financial institutions such as the European Investment Bank and the Nordic Investment Bank.

The State Budget Act regulates the procedures and conditions for providing state guarantees. It stipulates that state guarantees can be given only to SOEs where the State has control (over 50 per cent ownership), the company is sufficiently creditworthy and the obligation is directly related to the performance of public functions or the requirement for a state guarantee is provided by law.

As of the end of February 2009, the Ministry of Finance had loans opened with three state entities (Kunstimuuseumi Ehituse SA a [foundation], Lennuliiklusteeninduse AS [an SOE providing air navigation services], and AS Eesti Raudtee [railway SOE]). The state also provided guarantees on loans provided by the Nordic Investment Bank, the European Investment Bank and the Nordea Bank PLC Eesti to the state Post, Tallinn Airport and the state television (which has merged with the radio broadcasting service).

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