Sustaining Ukraine’s Breakthrough

George Soros

FEB 26, 2014
.



NEW YORK – Following a crescendo of terrifying violence, the Ukrainian uprising has had a surprisingly positive outcome. Contrary to all rational expectations, a group of citizens armed with not much more than sticks and shields made of cardboard boxes and metal garbage-can lids overwhelmed a police force firing live ammunition. There were many casualties, but the citizens prevailed. This was one of those historic moments that leave a lasting imprint on a society’s collective memory.

How could such a thing happen? Werner Heisenberg’s uncertainty principle in quantum mechanics offers a fitting metaphor. According to Heisenberg, subatomic phenomena can manifest themselves as particles or waves; similarly, human beings may alternate between behaving as individual particles or as components of a larger wave. In other words, the unpredictability of historical events like those in Ukraine has to do with an element of uncertainty in human identity.

People’s identity is made up of individual elements and elements of larger units to which they belong, and peoples’ impact on reality depends on which elements dominate their behavior. When civilians launched a suicidal attack on an armed force in Kyiv on February 20, their sense of representing “the nation” far outweighed their concern with their individual mortality. The result was to swing a deeply divided society from the verge of civil war to an unprecedented sense of unity.

Whether that unity endures will depend on how Europe responds. Ukrainians have demonstrated their allegiance to a European Union that is itself hopelessly divided, with the euro crisis pitting creditor and debtor countries against one another. That is why the EU was hopelessly outmaneuvered by Russia in the negotiations with Ukraine over an Association Agreement.

True to form, the EU under German leadership offered far too little and demanded far too much from Ukraine. Now, after the Ukrainian people’s commitment to closer ties with Europe fueled a successful popular insurrection, the EU, along with the International Monetary Fund, is putting together a multibillion-dollar rescue package to save the country from financial collapse. But that will not be sufficient to sustain the national unity that Ukraine will need in the coming years.

I established the Renaissance Foundation in Ukraine in 1990 – before the country achieved independence. The foundation did not participate in the recent uprising, but it did serve as a defender of those targeted by official repression. The foundation is now ready to support Ukrainians’ strongly felt desire to establish resilient democratic institutions (above all, an independent and professional judiciary). But Ukraine will need outside assistance that only the EU can provide: management expertise and access to markets.

In the remarkable transformation of Central Europe’s economies in the 1990’s, management expertise and market access resulted from massive investments by German and other EU-based companies, which integrated local producers into their global value chains. Ukraine, with its high-quality human capital and diversified economy, is a potentially attractive investment destination. But realizing this potential requires improving the business climate across the economy as a whole and within individual sectors – particularly by addressing the endemic corruption and weak rule of law that are deterring foreign and domestic investors alike.

In addition to encouraging foreign direct investment, the EU could provide support to train local companies’ managers and help them develop their business strategies, with service providers remunerated by equity stakes or profit-sharing. An effective way to roll out such support to a large number of companies would be to combine it with credit lines provided by commercial banks. To encourage participation, the European Bank for Reconstruction and Development (EBRD) could invest in companies alongside foreign and local investors, as it did in Central Europe.

Ukraine would thus open its domestic market to goods manufactured or assembled by European companies’ wholly- or partly-owned subsidiaries, while the EU would increase market access for Ukrainian companies and help them integrate into global markets.

I hope and trust that Europe under German leadership will rise to the occasion. I have been arguing for several years that Germany should accept the responsibilities and liabilities of its dominant position in Europe. Today, Ukraine needs a modern-day equivalent of the Marshall Plan, by which the United States helped to reconstruct Europe after World War II. Germany ought to play the same role today as the US did then.

I must, however, end with a word of caution. The Marshall Plan did not include the Soviet bloc, thereby reinforcing the Cold War division of Europe. A replay of the Cold War would cause immense damage to both Russia and Europe, and most of all to Ukraine, which is situated between them. Ukraine depends on Russian gas, and it needs access to European markets for its products; it must have good relations with both sides.

Here, too, Germany should take the lead. Chancellor Angela Merkel must reach out to President Vladimir Putin to ensure that Russia is a partner, not an opponent, in the Ukrainian renaissance.


George Soros is Chairman of Soros Fund Management and Chairman of the Open Society Foundations. A pioneer of the hedge-fund industry, he is the author of many books, including The Alchemy of Finance, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means and The Tragedy of the European Union.

Last updated: February 26, 2014 7:08 pm

The danger is that directors talk to the loudest voices but spurn contact with anyone else

©Ingram Pinn

At 78, Carl Icahn shows little sign of retiring, or of becoming more polite. After finally prodding Forest Labs into a $25bn takeover by Actavis, he renewed his attack on eBay this week, accusing John Donahoe, its chief executive, of being “completely asleep or, even worse, either naive or wilfully blind”.

This is becoming a fruitful decade for Mr Icahn and fellow hedge fund agitators, such as Dan Loeb of Third Point. From being reviled in the past as corporate raiders and “greenmailers”, they have rebranded themselves effectively as activist investors, willing to fight and defeat entrenched and complacent boards of directors and executives while pension funds slumber.

But larger institutions should beware of outsourcing their activism to packs of hedge funds that may, or may not, have their interests at heart. It makes for an easier life, and it can bring rewards for little effort or outlay. It also means taking a great deal on trust.

Activist investors are steadily overturning the US tradition of shareholders deferring to executives save for cases of blatant misconduct or mismanagement, when everyone calls in the lawyers. They have won the argument that investors have a right to express their views, overturning the assumption that insiders know best.

The danger is that directors end up talking to the loudest voices in the room – the funds who publicly call them idiots – while spurning contacts with anyone else. By the time it comes to a showdown with an agitator such as Mr Icahn, they have little hope of getting others on their side. That is, as some are coming to realise, stupid.

In other words, directors and investment institutions have a mutual interest in talking to each other routinely, rather than waiting to battle in a Delaware courtroom or accepting Mr Icahn’s lead. Two-way communication does not sound like a very radical notion but it has come slowly to the US.

The tradition of arm’s length antagonism between boards and unhappy investors goes back to the late 1970s, when Mr Icahn rose to fame. Martin Lipton, a founding partner of the corporate law firm Wachtell, Lipton, Rosen & Katz invented the poison pill defence in 1982 as a way for boards under siege to block raiders.

The poison pill endures – it was, for example, deployed by Netflix against Mr Icahn in 2012 – and Mr Lipton is still hard at work. But the intellectual tide has gradually turned against him. Mary Jo White, chair of the Securities and Exchange Commission, argued in a speech in December that “there is widespread acceptance of many of the policy changes that so-called activists seek”.

Indeed, Mr Lipton seems to have lost a recent argument that he really should have won. Wachtell Lipton petitioned the SEC two years ago to tighten up lax US disclosure rules that have allowed hedge funds to build up stakes in target companies without having to show their hands promptly, as they do in the UK, Australia and elsewhere.

Lucian Bebchuk, a Harvard professor who has tussled constantly with Mr Lipton in the cause of shareholder rights, promptly swung into action, arguing that the existing rules are strict enough. So far, the SEC has not acted – Mr Lipton has been poisoned by his own pill.

The temptation now is for giant institutions such as Fidelity and BlackRock to freeride with activists. The latter can build stakes of up to 5 per cent (often more if they act together or use derivatives to mask their activities) before declaring an interest and waging war. If they force the company into a deal, or into distributing cash to investors, everyone gets a payout.

That works fine if the interests of activists and the bigger institutions are similar. In some cases they are – Mr Icahn insists that “we do not buy securities with the intention of agitating for a quick ‘pop’ and then ‘flipping’ them for a speedy profit”, and Mr Bebchuk’s research indicates that hedge fund activism tends to improve the operating performance of target companies.

But this is not inevitable – activist investors are biased towards events, such as a merger, rather than steady improvement that increases long-term returns. “Activists are good at presenting their views as long-term and mainstream investors have to chip away at that and reassure themselves it is genuine,” says Michelle Edkins, BlackRock’s head of corporate governance.

There is not much time if a company has remained aloof from investors until it becomes a target. “The dialogue must start on a sunny day because by the time [a company’s directors] get out there on a rainy day, the game is over,” says Jim Woolery, deputy chairman of the New York law firm Cadwalader, Wickersham & Taft.

In the past, a board could deploy a poison pill and dismiss any critical investor as a greenmailer. There is less chance of that being sufficient now activism is respectable. Activist funds have $80bn under management and succeeded in 70 per cent of campaigns last year to block or alter the terms of agreed corporate deals, according to the law firm Simpson Thacher.

The formation this month of the Shareholder-Director Exchange, a body intended to facilitate direct conversation between institutional investors and board directors, is one sign of attitudes changing. Both sides realise that, if they leave it to others to seize the initiative, they may not like the result.

US capital markets have moved on from equating investor activism with asset-stripping. They have yet to reach the point where activism does not always mean a fight.

Copyright The Financial Times Limited 2014.