The selling of state assets, from million-dollar bank loans to properties and used office equipment, is notorious for cronyism and poor value. Public sector assets are worth twice the value of global GDP, according to IMF estimates. But most governments don’t know what they own or what it’s really worth. ProZorro.Sale is a pioneering approach to help governments tap into the hidden potential of their assets and generate more revenue for the state. With a radically transparent design, and with open and fair bidding, the online auction system allows government agencies to sell or lease items that were previously impossible or very inefficient to trade. Transactions through the system have added more than US$870 million to Ukraine’s national and local budgets in the last three years.
The Metro-Hostel in Kyiv is not your typical budget accommodation. Guests sleep in comfortable four-bed dorms made from two old train carriages onced owned by the city’s subway authority. When the carriages were no longer railworthy, rather than turning them into scrap metal, the Kyiv Metro sold them for around US$20,000 through the government’s new, transparent online auction system. From the moment they were advertised, it took two weeks to complete the sale. Bureaucratic red tape would have rendered such items worthless to Kyiv Metro in the past — even giving away the carriages as scrap used to be complicated because of legislative restrictions.
From million-dollar bankrupt bank loans to used office equipment, each day, Ukrainian state entities sell or lease hundreds of assets to private buyers through the centralized digital auction system, ProZorro.Sale. Launched three years ago, the system is a pioneering approach to help governments tap into the hidden potential of their assets and generate more revenue for the state. With a radically transparent design, and with open and fair bidding, the system allows government agencies to sell items that were previously impossible or very inefficient to sell. It has improved trust and participation in the market, established better prices and increased the market’s size, fairness and efficiency.
Just five years ago, transactions like these would have been unthinkable in Ukraine, and still are in most countries. The management and sale of public assets is a complex and murky business that poses problems for governments everywhere. Lousy management, poor inventory oversight, and dodgy dealings are rife. Ukraine, like many of its former Soviet neighbors, has become notorious for shadowy schemes based on personal patronage that allow oligarchs to purchase state assets for rock-bottom prices. Instead of contributing to the public purse, the revenue accumulates in the pockets of corrupt officials. Advanced economies aren’t immune either. Most governments aren’t good at keeping track of what they own or determining the value of their assets. In fact, only a handful of countries have a comprehensive overview of their public sector balance sheets. Last year, the IMF put the public wealth of 31 economies in the ballpark of US$101 trillion, or 219% of gross domestic product (GDP), but admits this estimate should be taken with caution due to various data quality issues.
“Knowing what a government owns and how they can put their assets to better use matters because they can earn about 3% of GDP more in revenues each year and reduce risks, all at once,” notes the IMF. “That’s as much revenue as governments make from corporate income tax receipts in advanced economies. Governments can put this money toward better schools, hospitals, or other priority spending.”
In the wake of the global financial crisis, government debt in leading economies increased massively, making the need to manage their assets effectively ever more important. It is a particularly acute challenge for governments looking to sell a large volume of assets competitively and fast, such as those adopting a “bad banks” strategy to recover after an economic crash. For Ukraine, this was the proverbial necessity that led to the new auction system’s invention.
Selling ‘toxic’ bank assets fast amid state capture
ProZorro.Sale was first piloted to sell off non-performing loans and other assets from bankrupt banks. After the Maidan revolution, half of all Ukraine’s commercial banks collapsed, leaving the government with around US$20 billion (face value) worth of assets to liquidate, equal to 20% of Ukraine’s gross domestic product, the national budget for that year, or more than 60% of bank deposits by Ukrainians. With a legal requirement to complete the sales within five years, the agency responsible for the liquidation process, the State Deposit Guarantee Fund, struggled to build a system that would be “effective and impartial” enough to generate revenue on such a large scale. Collusion and insider trading were major risks — a report by the Fund later found that 57% of loans from Ukraine’s top five banks had been tied to shady businesses; oligarchs had effectively been using Ukraine’s banking sector as their personal piggy bank and there was a high chance they would attempt to tamper with any asset sales.
So the Deposit Guarantee Fund turned to the Ministry of Economy, which had developed a suite of anti-corruption solutions for the public sector in partnership with activists, tech experts and businesses. Their main tool was an internationally-recognized procurement system, ProZorro, that was proving remarkably effective in reducing corruption, improving efficiency and increasing competition in one of Ukraine’s most problematic markets. The system ran on open source technology, modeled on the Open Contracting Data Standard (OCDS). This made it cheap and fast to build. Information could be easily shared across different government agencies and with a wide market of potential suppliers.
If the ProZorro team had managed to establish an efficient and transparent system for government purchases, the Fund’s leadership thought, perhaps they could build one for sales too.
More: Read about the open public contracting system that inspired ProZorro.Sale and its impact
It was important to make the system transparent and independent. Many of the Fund’s debtors were politically exposed persons (see KSE study p.14), and tampering had been a problem for other companies offering asset auction services in the past. With no interest in settling their debts, corrupt politicians and oligarchs had the resources to sabotage the sale process by canceling auctions, paying bribes or simply threaten the bidding platforms’ staff, says Oleksii Sobolev, CEO of the state-owned enterprise that runs ProZorro.Sale: “I know of stories where directors of [bidding platforms] hid under the table while the online auction was ongoing because people were trying to break down the door trying to stop the servers.”
So to reduce the risk of undue influence on the high-value sales, the job of developing the electronic trading system was outsourced to an impartial organization with an impeccable reputation, the anti-corruption NGO Transparency International Ukraine. This “start-up” model also allowed the government to be more innovative and test new ideas without taking on the risk of a big bang failure.
A complaints review body was established to guarantee that the winner selection process was fair. It operated on the principle of complete transparency — all meetings were open and decision were published online.
“It was a great mechanism to regain trust from business,” says Iliya Mykhailov, who initiated the project while working for the Deposit Guarantee Fund and is now chairman of ProZorro.Sale’s board. “Over 2 years, we reviewed more than 1200 complaints and 99.6% of decisions were successfully implemented. Business felt protected, and that was very important.”
The first sales of bank loans took place in October 2016. Over the following year, successful auctions generated UAH 2.2 billion (US$91 million) in contracted value for the Deposit Guarantee Fund. But unscrupulous borrowers continued their attempts to delay or block the process in hopes of avoiding paying off their loans, says Sobolev. So in October 2017, the DGF and ProZorro.Sale team worked with the Kyiv School of Economics to alter the format of the auction process to a so-called hybrid Dutch model, which would make the sales faster (auctions could be completed in a single day) and engage new buyers. This would help to curb insider trading, increase revenues and improve competition (for reasons we discuss in more detail below). After switching to the new format, the sales were more rapid and successful more often. It took two months on average to sell an item via the new hybrid Dutch format compared to three months via the original format. Some 9.5% of Dutch auctions were successful, against 2.3% of all auctions using the original format. The Dutch auctions also recovered a higher percentage of the face value of loans sold, 24% compared to 19% for the original auctions.
How the ProZorro.Sale auction system works
What sets ProZorro.Sale apart from other government privatization and asset sales systems is its tamper-proof, network design. More than 50 privately-owned and a couple of state-owned online platforms are affiliated with the system and link up to a central database hosted by the government.
Sellers can advertise an item through any one of the platforms, then potential buyers on all 50 or so platforms can view the offer and make a bid. A powerful, publicly-available analytics tool automatically identifies suspicious sales, and important information about the auctions are visible to the public in real-time in a machine-readable format. This means auctions can’t be held in secret, auction documents can’t be lost or hidden, and the system can’t be bribed or tricked. This multi-platform approach is unusual and made possible because the ProZorro.Sale system is modeled on a universal open data format called the Open Contracting Data Standard (OCDS) that allows information to be collected, centralized and published in a standardized and structured way, using a unique ID for each transaction. This makes it easy to share data across different systems without necessarily having to modify the software that they run on. People anywhere can create tools to share or analyze that data, which allows anyone to check that the transaction process is fair and follows the rules. Repurposing existing technology that used the OCDS allowed the ProZorro.Sale team to build the e-auction system within four months and for a cost of US$100,000.
It’s a model that has huge potential to be replicated elsewhere, as ProZorro.Sale’s Sobolev explains in a podcast with the Centre for International Private Enterprise: “USA.gov has a list of different websites that sell the same stuff, which means for you as a buyer, you have to first know about those websites, and if you want to buy some real estate [for example] from the government, you need to check all seven websites, they all have different procedures, so really complicated stuff. What we do [is] unify all those websites that the government or market has.”
The auctions themselves follow two types of auction design. The original auction process is an ascending English auction, in which bidders can submit increasing offers over three rounds. But this design is more likely to favor insiders who know what the item is worth, while outsiders bid conservatively, if they participate at all, because they are unsure of the asset’s value. So the process has been adjusted to a hybrid Dutch model that involves three rounds of bidding. The first round determines the market value of the item (that is, a classical dutch descending clock auction): the price starts at the book value of the lot and automatically drops at regular intervals until a bidder agrees to the price displayed, at which point the auction stops and the offer is visible to all participants. In the second round, the rest of the bidders have a chance to make sealed bids higher than the first-round offer. The value of the bids is then revealed, and the bidder who stopped the clock in the first round now bids within the best and final round, giving them an opportunity to increase their final price if they want to ultimately win the lot. Thus, this improves the revenue generated for the seller.
“The hybrid Dutch auction model is a unique combination of existing auction elements that is not found elsewhere in the world. It is a product of great academic effort put together by DGF, Kyiv School of Economics and ProZorro.Sale team,” says Mikhailov. “The utilization of this model could be seriously considered within the ‘Vienna Initiative’ as a fast and transparent way to deal with European Union’s non-performing loan problem,” he adds, referring to the framework for safeguarding financial stability in emerging Europe established in the midst of the global financial crisis.
Over less than two years, the government recovered around UAH 6.2 billion or US$250 million from sales of non-performing loans, according to analysis done by the Kyiv School of Economics, equivalent to 22% of the face value of all loans put on sale or an average sale price of 30% (contract value to face value). This is a remarkable achievement considering the size of the crisis on Ukraine’s hands, and a better performance than most countries using alternative methods to deal with non-performing loans, where data is available (see KSE study, p.11).
With these promising results from the sale of bank loans, the ProZorro.Sale team expanded the project. As of October 2019, the system can be used to sell and lease around 38 different types of assets, including those from failed banks, as well as other national and sub-national government agencies and some commercial firms. Items up for auction include credit portfolios, state-owned enterprises, mining licenses, land, vehicles, billboard advertising rights, buildings, scrap, and minor assets, such as cars or computers. With complementary regulatory reforms, the system could be expanded to other areas, such as renewable energy and private bankruptcy procedures. The Parliament also recently adopted a law on state and municipal assets that will make all public asset management completely transparent and much more efficient.
Most auction systems require log-in access or sell a limited number of assets, but the open design of ProZorro.Sale allows it to be used across a network of more than 50 commercial platforms (and some government platforms) that earn commissions for successful sales. This encourages brokers to offer competitive, customer-oriented services that attract investors. A fraction of each successful sale also goes to the ProZorro.Sale enterprise to cover the system’s maintenance and administrative costs.
And it’s working: almost 16,000 bidders use the system as of October 2019. There are also more opportunities for companies to participate, with the volume of auctions rising continuously from one seller and 12,888 auctions in the first quarter of 2017 to 499 sellers and 20,370 auctions in the third quarter of 2019.
Bidders say auctions have improved. A survey of potential buyers found 74% said they trust the ProZorro.Sale system, while around half said the system has had a strong positive effect on the quality of auction processes.
“We had an opportunity to participate in auctions with the previous [paper-based] system and the new ProZorro.Sale system,” says Volodymyr Yaskiv, an entrepreneur who bought a commercial building in Lviv to renovate as a modern business center. “I can confidently say that the ProZorro.Sale system is much more convenient. We had an opportunity to submit all the documents without leaving our office, pay a fee for the auction and buy this premises.”
Creating a formalized process for the first time
One of the most active sellers in the ProZorro.Sale system is Ukrgasvydobuvannya (UGV), the main gas producer in Ukraine and a subsidiary of the national oil and gas company, Naftogaz. UGV, which is also the largest natural gas producer in Central and Eastern Europe, uses ProZorro.Sale both as a buyer (for licenses for gas extractions) as well as a seller. In the last two years, it has sold UAH 120 million (US$5 million) worth of “obsoletes” such as scrap metal, used wheels and used oil, as well as UAH 20 million (US$830,000) of used materials like tubes, and UAH 10 million (US$413,000) of fixed assets like buildings.
Before adopting ProZorro.Sale in 2017, the enterprise had no centralized or formal process for selling off assets, according to Pavlo Nazarok, head of UGV’s obsolete sales division. This meant all sales were “relational”; in essence, deals were made via phone calls with friends. There were lots of issues with this relational approach, from poor efficiency and low prices to criticism from the public and companies that the system was unfair and opaque. All that has changed. Through ProZorro.Sale, deals are fully transparent and the results can’t be understated: they have seen a monthly year-on-year price growth of 20% on the same items (identical lots of scrap metal) and the average number of bidders is about 3.5 per auction.
UGV is also one of more than 20 buyers that acquired mineral extraction rights through ProZorro.Sale auctions since March 2019. The 35 auctions generated a record-breaking US$20 million for the State Service of Geology and Subsoil (compared to US$5 million in the last eight years combined), with an average increase on the starting price of 64%.
Real estate of ex-Soviet state enterprises
The Ukranian Postal Service (UkrPoshta) has produced some of the most impressive empirical results of the entities adopting ProZorro.Sale so far. As a former Soviet state, Ukraine has almost 3,500 state-owned enterprises (SOEs), which are notoriously rife with mismanagement and corruption. Few of them have a complete inventory of their assets, let alone the capacity to manage them effectively. In fact, some 40% of these enterprises are inactive and operate only on paper. UkrPoshta is one of the largest SOEs and the first to implement the ProZorro.Sale auction system, as part of its vision to turn a “communist giant” into a service-oriented model, according to Dmitry Sennychenko who led Ukrposhta’s real estate asset management and infrastructure team when the agency adopted ProZorro.Sale and was recently appointed head of Ukraine’s State Property Fund, which is responsible for privatization. The postal service is undergoing a series of radical reforms to modernize and improve its transparency, overhauling everything from its customer services, to its infrastructure, and sorting processes.
UkrPoshta has a large amount of real estate which has often been misused. It owns 12,730 buildings and some 30% of its 1.3 million square meters of land is not used (equivalent to around 100 football fields). Maintenance costs are a burden too, with rising utility charges and a need to meet public safety regulations and improve energy-efficiency. UkrPoshta’s property is mostly located at central train stations, reflecting an outdated infrastructure network, designed for a time when post and parcels were distributed by rail. Ukrposhta needs to sell that old land and buy new properties suitable for a modern logistics system that relies on trucks and cars, and hubs rather than small logistics centers in train stations.
But after corporatization in 2017, Ukrposhta’s land became the statutory property of the company, which could be leased but not sold (there is a draft law in parliament now, which if adopted would be a breakthrough for selling the land).
After building a core team and developing international regulations, UkrPoshta completed its first auctions in September 2017. Over the following two years, the enterprise announced 9100 auctions, out of which 838 were successful and expanded their operations to a nationwide system. The lots auctioned equaled 112,715 square meters of real estate, while another 56,736 square meters were leased (signed contracts and contracts pending signatures). Ukrposhta has also helped Ukraine’s national broadcaster to introduce a system for leasing assets like radio studios, and shared its methodology with Ukrainian Railways, which experienced similar problems to the postal service.
The price is right
Determining the value of an asset is typically a very difficult process for governments. A major advantage of ProZorro.Sale is that the auction system allows “the market to decide what is cheap or not,” says Sennychenko. In the past, leasing assets was an extremely complicated, untransparent process that took around six to nine months and involved multiple agencies (the State Property Fund, the Ministry of Infrastructure and Ukrposhta). The price was agreed with the potential leasor and the State Property Fund gave the final sign-off on the contract. The sale often didn’t reflect the true market price, meaning Ukrposhta was losing a lot of potential revenue. Now, the process takes 20 days on average and the average lease price has grown by 60–80% on the same buildings, according to Sennychenko, (the highest increase was up to 300%), since leases can be readvertised on ProZorro.Sale when the initial lease period comes to an end. There has been a dramatic rise in the volume of leases, which has generated significant revenue: in 2019 so far, they have pocketed more than five times as much revenue from real estate leases as the whole of 2016, before adopting the auction system.
Ukrposhta would now like to use ProZorro.Sale to offload other heavy assets that they don’t need. For example, they conducted an audit of 15 resorts, which are a major source of corruption, and closed them.
Expanding the local market
Opportunities are growing for regional state enterprises, cities and local businesses. More than half of the system’s sellers are local entities (523 out of 1022, up from 34 in the system’s first year). Almost 72% of those sellers have successfully auctioned at least one item. The city of Lviv is the leading seller in small privatizations (meaning state and municipal property with a book value below UAH 250 million). Thanks to these auctions, businesses who buy the real estate are opening the doors of establishments in the picturesque city center to the public for the first time in years and the profits are being reinvested to benefit taxpayers.
“We earned UAH 416 million (around US$16 million) to the city budget thanks to ProZorro.Sale system; maximum transparency, maximum openness,” Lviv Mayor Andrii Sadovii said in a video promoting the auction service. “I strongly recommend other cities to join the ProZorro.Sale system if you need additional money for education, health, road repairs.”
The anti-corruption NGO Transparency International Ukraine is tracking municipalities’ uptake of ProZorro.Sale as part of a project to improve transparency in Ukrainian cities.
“People from one region will buy from another region,” says Sobolev. “It’s putting money back in the local community.”
How stakeholder engagement helps overcome challenges
The technical changes are the easiest part of the reform, particularly as it relies on open-source non-proprietary software that makes the development process quick and relatively cheap.
“The technology is open source, so anyone can take it. Many other countries could be interested in this technology. We’re talking to the European Union, CIS [Commonwelath of Independent States] countries, and the South Asians; mostly countries that have problems with trust and transparency,” Sobolev says.
The bigger challenge has been garnering widespread political support and fending off the vested interests that continue to influence the country’s institutions. But the improvements delivered by the system have been so dramatic that they’ve changed the market’s expectations. Government employees have seen how their work has become more efficient, says Sobolev, and time-consuming inquiries from prosecutors have become less frequent.
ProZorro.Sale reformers are also concerned that some entities are engaging in “open washing”, adopting the system to appear more transparent without making any substantive structural reforms. Although, this behavior is quickly obvious in the ProZorro.Sale system; for example, if all the entity’s auctions are unsuccessful, it could indicate a need to investigate further. And non-profits groups and media that monitor the sales readily name-and-shame any attempts at corrupting the auction process.
The ProZorro.Sale team has worked hard to lobby to change the often outdated and overly bureaucratic laws so that certain sales are authorized to run through the system. Most sectors have unique, legally-binding procedures that were designed for paper-based system and are poorly suited for electronic transactions, sometimes comically so. For example, the old land lease auction laws in Ukraine required auctioneers to hit a gong during the sale, so the ProZorro.Sale team added an audio file to comply with this requirement when moving to the online system. Overall, the ProZorro.Sale team seeks to develop an adequate regulatory framework for asset sales based on rules similar to those in the EU or US.
The best motivator for radical public sector transformations seems to be fiscal crisis, says Eliza Niewiadomska, who works for the European Bank for Reconstruction and Development (EBRD) supporting countries to implement major policy reforms. In Ukraine, it was the Euromaidan that created the political will and a new spirit of innovation, according to ProZorro.Sale’s Sobolev.
“After the revolution, we had this huge opportunity for change. Now, we have the political will, the people are ready to try out new things, and from there we can scale up the system.”
Now Moldova, which experienced a major banking crisis in 2014, is one of the countries adopting the ProZorro.Sale model to reform its public asset management. A “M-Sale” system is set to be launched by the National Bank of Moldova and the EBRD in 2020.
“We have a lot of problems here [in Ukraine], but we look at what works and we understand that complete transparency really works,” Sobolev says.
ProZorro.Sale is a ground-breaking system for generating revenue, but it also provides a remarkable public record of the historic changes taking place as Ukrainians rebuild their nation. Land, buildings and businesses that have been neglected for years are getting a chance to start anew: the old restaurant in Lviv which will be operational for the first time in two decades — “I am sure that new jobs will be created there and new taxes will come to the city budget,” says the mayor; the half-built conference hall, purchased from Lviv’s tax office, that will become part of the Ukrainian Catholic University’s future extension plans; the popular heritage building in the city center of Ternopil that attracted bids from 39 women, men, and small businesses; or the small office in Dnipro city that had a balance sheet value of US$1 and sold for over $15,000.
Each auction tells its own story of new opportunities for Ukrainians, and beyond.
Story written by: Sophie Brown, Open Contracting Partnership.