FEATURE-CCC Proposals on State Owned Enterprise (SOE) Reform

By the Ceylon Chamber of Commerce (CCC)

The presence of SOEs in strategic sectors of Sri Lanka is proof of the significant value creation it can generate through spillover effects. The societal returns too are greater as it links to our day-to-day activities such as the water we drink, the electricity we use, or even the bus or train we ride on. Therefore, addressing the suboptimal performances of SOEs by inculcating a performance oriented culture whilst ensuring transparency and accountability are warranted at this difficult juncture of trying to recover from economic turmoil.

While the Government may need to operate some SOEs due to reasons such as providing essential goods and services at an affordable price, there is a large number of SOEs which are purely engaged in commercial activities that can function more efficiently and effectively under private sector ownership. Hence, we recommend that SOEs falling into the latter category be divested either fully or partially through a well-structured, open and transparent process.

In this regard, the Public Sector Reform Steering Committee of the CCC, through its Sub Committee on SOE Reform recently presented a set of proposals to the policy makers on SOE reform.

1.       Model for the SOE Reform Agency

The objectives of the SOE Reform Agency should be to;

•       To separate the state’s ownership functions from its policy-making and regulatory functions in order to help avoid or minimise potential conflicts of interest.

•       To minimise the scope for political interference and bring greater professionalism to SOEs.

•       To promote greater coherence and consistency in applying corporate governance standards and performance management systems across all SOEs.

It is imperative to ensure that the SOE agency would not be relegated to play a passive role with little authority over the SOEs. It should be able to collaborate with line ministries and other related agencies (including the Public Enterprise Department), and gather information related to SOEs. It should also be shielded from short-sighted political pressures and government interferences in operational decisions.

1.1     Holding company

The ideal scenario for the SOE agency would be to have a holding company established under the Companies Act No 7 of 2007 and bring all the SOEs under the control of the holding company. So that as the parent company, the holding company will have the authority and power to control entities directly under it. A company-type structure will also have a separate legal identity, their own governance bodies and will be exempt from cumbersome government polices relating to remuneration policies and procurement processes.

There are 36 SOEs that are governed by the ‘Administer Part II’ of the Finance Act No 38 of 1971 and 86 SOEs established under the Companies Act No 7 of 2007 . Out of the SOEs established under the Companies Act, about 44 per cent of the SOEs are not owned by the Treasury (the majority stake is not held by the Treasury) and most SOEs are also gazetted under different line ministries. According to the Gazette Extraordinary No 2289/43 published on 22 July, 2022 and amendments thereof, these line ministries have a broad spectrum of powers and functions over the SOEs and this is detrimental for the SOEs performance and driving reforms. 

A critical goal of the SOE agency is to separate the state’s ownership functions from its policy-making and regulatory functions to minimise the conflicts of interest. The SOE agency should be the specialised entity that serves as the shareholder representative with oversight responsibility for all SOEs. It should be responsible for exercising all ownership functions on behalf of the state as the owner, while the line ministry should only be responsible for policy-making in relation to the sectors in which SOEs operate. This is a model practiced across many countries.

Therefore, we recommend that all SOEs should move away from this complicated dual ownership model in which line ministries and other entities have ownership responsibilities, and to move to a centralised ownership model where all the SOEs are under the holding company.

1.2     Interim Arrangement

If there is undue delay in setting up the holding company structure then in order to expedite the reform process, an alternative model can be looked at. Upon examining the experience of various SOE agencies Sri Lanka has had over the past couple of decades, such as Strategic Enterprise Management Agency (SEMA) and State Resources Management Corporation Ltd (SRMC), we recommend that this alternative model in the interim period, be an agency established by an Act of Parliament similar to the Public Enterprise Reform Commission (PERC), which had many successes including the divestment of Sri Lanka Telecom, Distilleries Corporation, Cement Corporation, Ceylon Oxygen, and Orient Lanka, amongst others. Pending legislative enactment, it can operate as a Unit under the Ministry of Finance.

However, this will only be a sunset agency until all the SOEs are brought under the Holding Company. Once all the SOEs are under the holding company, the agency under the Act of Parliament will cease its existence.

1.3     Appointments to SOE Boards

In addition to bringing all the SOEs under one umbrella and moving away from the dual ownership model, competent boards of directors for all SOEs should be appointed through a robust and transparent mechanism. This would further help SOEs to operate at greater arm’s length and limit political interference, since, a board bears the ultimate responsibility for the stewardship and performance of the SOE, and not a line a ministry or any other supervisory body.

We propose a similar mechanism to what is available in Malaysia where the SOE agency carries out the appointment process of SOE boards. Here, the nomination committees of listed SOEs in Malaysia identifies potential board candidates in conjunction with Khazanah (the holding company) and others. It prepares the short list for approval by the board, and then submits the approved list to Khazanah for appointment.

After the initial boards are appointed to the SOEs by the SOE agency/holding company as applicable, a system of rotation can also be introduced so that the board continuity is maintained with a couple of directors retiring each year and being available for re-election or replacement. No director should be permitted to serve more than two consecutive terms of office.

As the Board of Directors of the Holding Company will have significant power and influence over the appointment of boards to SOEs under it, there must be a transparent and independent process to appoint this Board, to ensure those with high standing and no apparent conflicts of interest are selected.

1.4     Internal Structure

Finally, we propose that the SOE agency operates under the Ministry of Finance (MoF). Countries such as Singapore, Malaysia, India and UK too have their SOE agency under the MoF.

1)      Framework for Practical Implementation of SOE Reform

As a first step in identifying SOEs for divestment, the subcommittee on SOE Reforms developed a framework to understand if the SOE should remain under government ownership or not. The framework followed is given below.

1.       Whether it provides an essential good or service

2.       Whether the private sector is capable of delivering it

3.       Whether sufficient competition is there to ensure appropriate quality and pricing

In this regard, 19 SOEs were identified as entities that require government ownership, 127 SOEs were identified as SOEs that do not require government ownership and four entities that require decoupling of regulatory and operational activities after which some parts can be spun off and considered for divestment. A further 10 SOEs were identified as those requiring more in-depth analysis using special expertise to restructure or liberalise.

Next, the SOEs that were identified for divestment (SOEs that do not require government ownership), were prioritised under immediate, medium and long term. The framework for segmentation was developed with four metrics. These four are;

1.       Impact on Budget       

2.       Absence of Controversy       

3.       Ease of Implementation       

4.       Ability to attract Global Players     

When an entity scored high for the above metrics, it received a score of 3, medium received a score of 2 and low received a score of 1. The prioritisation under different phases was done according to the score each SOE obtained. When an SOE received a score of 8 or above it was placed under the Immediate Divestment category and scores between 5 and 7 were placed under Medium Term Divestment category.

The results obtained relayed 108 entities for immediate to medium term divestment and 19 entities for liquidation. This is in addition to the 19 entities that were identified for government ownership, 4 entities for decoupling and 10 entities which require specialised expertise to divest. 

The liquidation of the SOEs identified in that category can be carried out immediately without bringing them under the SOE agency or the holding company. Other entities will fall under the following divisions with the assigned mandate given below.

Therefore, we believe by carrying out the above proposed model for the SOE restructuring agency, holding company and proposed framework to carry out SOE reforms, it can help transformation of existing SOEs from fiscal burdens and into value creators so that SOEs can be an impetus for Sri Lanka’s growth and development, rather than serving as stumbling blocks.