Are defense investments compatible with the principles of sustainable investing? At a conference in Brussels, the answers ranged from “maybe” to a firm “no”.
The organization behind the Belgian sustainability label Towards Sustainability hosted a debate on Wednesday about one of the most contentious issues in the fund industry: are defense investments compatible with ESG (Environmental, Social, and Governance) sustainability criteria?
In response to Russia’s invasion of Ukraine, the European Commission has made defense investments one of its top priorities—especially now that the NATO alliance with the United States is under strain in the era of Trump II. But with European governments facing tight budgets, the Commission hopes that private investors will also be willing to contribute to the defense effort.
Can that additional funding be raised through sustainable funds? According to Pablo Fernandez-Cras, a policy officer at the European Commission, European ESG regulations do not categorically exclude any sector—defense included. He noted that some European texts argue defense investments promote peace and therefore social sustainability, which could open the door to including defense stocks in ESG funds.
Do no significant harm
But Wim Van Hyfte, Head of ESG Investing at Candriam, sees things differently. For him, there is no place for defense stocks in ESG funds on principled grounds. “Sustainable investing has core principles. One of the most important in the European framework is ‘Do No Significant Harm’ (DNSH). I find it difficult to believe that defense companies could meet that criterion.”
His second argument is the lack of transparency in the defense sector, which also contradicts the philosophy of sustainable investing. “The defense sector is notorious for its opacity—for example, who the ultimate end-user of the weapons is, or when it comes to governance issues.”
Jürgen Verschaeve, Chief Investment Officer at KBC Asset Management, sees that as a major obstacle as well.
“The defense sector will never be as transparent as other sectors by its very nature,” said Jan Pie of ASD, the umbrella organization for European defense companies, during the debate. For instance, it’s self-evident that governments want to keep certain military technologies secret.
However, ASD says it is open to dialogue to help make defense companies compatible with ESG fund participation. “Our request is: tell us the criteria we need to meet.”
What the defense industry mainly wants to avoid is being entirely excluded and lumped together with banned sectors such as tobacco, alcohol, or gambling.
Some advocate for classifying defense as a separate investment category, given the unique role it plays in society. But for Van Hyfte, such a special status is hard to reconcile with the ESG philosophy. “We can’t operate with double standards. As ESG fund managers, we must be able to apply the same requirements to defense as we do to, say, energy or consumer goods.”
“Are there weapons involved?”
Marnix Arickx, CEO Belgium at BNP Paribas AM, says he does not automatically exclude all defense companies from sustainable funds. But the step from “theoretical possibility” to actual investment is not straightforward.
“As a bank, we’ve made a commitment to finance the European defense sector. And yes, defense does have a social role. But before a defense company can be included in one of our ESG funds, it will have to meet the 35 ESG criteria we impose. Defense is a challenging sector in that regard, just like mining or the diamond industry.”
Beyond the major ethical principles and the nuances of European sustainability rules, Verschaeve (KBC) also looks at it from a purely practical standpoint.
“The vast majority of our retail clients who want to invest sustainably are not familiar with European regulations. I usually get just two questions: ‘Is there oil involved?’ and ‘Are there weapons involved?’ In other words, exclusions provide a shortcut to a clear message.”
According to Arickx, even some institutional clients—like pension funds—use such simple rules of thumb.
A possible solution
To help governments finance the European defense sector, Verschaeve sees more potential in issuing government bonds rather than raising private capital through (sustainable) funds.
Some European policymakers have previously advocated for government bonds whose proceeds would be used exclusively for defense investments. A major advantage is that the government remains solely responsible for those defense investments and does not delegate those sensitive decisions to private shareholders.