For decades, investing in the defence industry was widely considered incompatible with sustainable finance. But as the geopolitical situation has changed dramatically, protecting democracy has become a priority.
The ongoing war in Ukraine and shifting global power dynamics have led European governments to increase their defence spending. In response, financial markets are being urged to support this effort. For sustainability minded investors, this represents a U-turn. How and to what extent is it possible to combine both objectives: to support the necessary effort to beef-up European defence, and at the same time to stick to sustainability principles?
The role of financial markets in defence investment
Historically, defence was not only excluded for ethical reasons but also due to a lack of investor interest. However, recent global events have forced a reconsideration of priorities. European governments, facing budgetary constraints, are calling on the private sector to help finance defence initiatives. Consequently, financial actors are now being asked to lift investment restrictions on the sector.
As a long-standing advocate for sustainable finance, DPAM nonetheless understands that an effort on defence be needed to protect democracy. After all, without democracy and economic freedom, there wouldn’t be any sustainable investment. Freedom and stability are essential for a thriving economy and to finance a fair sustainable transition. However, investing in defence must not compromise the fundamental principles of ESG investing. We must all bear in mind that weapons are inherently instruments of destruction, contrary to the need to build a sustainable future. Their use affects both people and the environment.
Moreover, Sustainability and security are inherently interconnected. Notably, environmental degradation and resource scarcity may fuel competition for resources, which is a frequent cause for armed conflicts. Thus, sustainability is a prerequisite for peace.. These two dimensions go hand in hand, as the European Commission has rightly understood, with its objectives for 2029 placing defence/security, sustainable prosperity, democracy, and social justice on an equal footing.”
The changing landscape of defence investment
Until recently, the exclusion of defence stocks was considered a fundamental requirement for any investment strategy with ESG legitimacy. Still, there are various ESG challenges affecting this industry. Firstly, the human rights risks associated with selling weapons. Secondly, the corruption risks which were historically very high, now seemingly slightly less, but still relevant, and thirdly all the other ESG risks associated with industrial activities.
Despite this shift, sustainable investors remain cautious. According to Florent Griffon, Senior SRI Specialist at Degroof Petercam Asset Management (DPAM), only a small minority of European ESG equity funds were invested in defence stocks until a few months ago. It is only very recently that such funds started increasing their allocation. And even so, their exposure to the sector remains limited, he asserts.
This suggests a gradual but limited move toward integrating defence into sustainable portfolios. This also suggests that sustainable funds remain reluctant to invest in defence. They are gradually starting to do it, to a limited extent. But clearly, it is mainstream funds that are, by nature, better positioned to invest in the sector, at least initially.
Ethical boundaries: conventional vs. unconventional weapons
To clarify, discussions about investing in defence focus exclusively on conventional weapons. Unconventional armaments, such as anti-personnel landmines, cluster munitions, and depleted uranium ammunition, remain entirely non-investable. Many European countries legally prohibit investments in these weapons, and international treaties reinforce these bans. Countries prohibit these weapons, in line with their own commitments as part of international treaties that ban these armaments.
Mainstream investment strategies are reassessing their stance on conventional weapons to finance the industry. Given the current geopolitical climate, some funds with limited ESG credentials are also starting to consider investing in defence stocks, as long as they are not exposed to controversial weapons. And also, provided the companies operate responsibly and adhere to good practices regarding human rights and business ethics.
Striking a balance: financing defence responsibly
The challenge for asset managers is determining how to support Europe’s defence needs while maintaining ESG integrity. The key considerations include:
- Assessing the type of defence investment
- Investors must distinguish between conventional and controversial weapons. Controversial weapons are banned in most countries.
- Not all defence-related products pose the same ethical concerns; cybersecurity and telecommunications, for example, carry fewer risks than ammunition production.
- Investors must distinguish between conventional and controversial weapons. Controversial weapons are banned in most countries.
- Understanding the demand for capital
- There is a debate whether the European defence industry needs capital from sustainable investment funds, at least at this stage. Other vehicles already appear well suited for this task, so we could start with these (mainstream funds, etc.)
- Mainstream investment strategies (SFDR Article 6) still represent over 40% of the European market and remain a primary source of funding.
- Alternative financing mechanisms, such as dedicated savings accounts (e.g., France’s defence savings initiative), offer additional capital avenues.
- There is a debate whether the European defence industry needs capital from sustainable investment funds, at least at this stage. Other vehicles already appear well suited for this task, so we could start with these (mainstream funds, etc.)
- Establishing responsible investment guidelines
- Defence investments should target responsible companies that comply with international laws and human rights standards.
- Companies in the aerospace and defence sector must demonstrate strong anti-corruption measures and robust governance frameworks.
- ESG risk factors, including climate impact, resource management, and human rights policies including along the supply chain, should be closely monitored.
- Defence investments should target responsible companies that comply with international laws and human rights standards.
Conclusion
The shifting geopolitical landscape has prompted investors to reconsider long-standing exclusions of defence stocks. While mainstream investment strategies are increasingly open to financing defence, sustainable finance principles must remain intact. For asset managers, the challenge lies in integrating ESG considerations to ensure that defence investments align better with responsible investing standards. It is also up to defence companies to adopt good practices, to gradually make the whole sector more responsible. Engagement with these companies can help them along this journey.
Ultimately, a balanced approach—one that safeguards national security while upholding ESG principles—will be crucial in navigating this complex and evolving issue. The conversation is ongoing, and how financial markets adapt will shape the future of responsible investing in the defence sector. Concomitantly, the sustainability progress of the aerospace and defence sector is also to be monitored.
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