Conflicts Ahead as EU Pushes Case for Defence
Clarification sought on the extent to which the bloc’s ESG-labelled funds can and should finance weapons under sustainable finance regulations.
The EU’s plans to boost investment in its defence industry cannot come at the expense of the integrity of the bloc’s sustainable finance framework, industry experts have said.
But the warning comes amid increasing signs that the European Commission intends for sustainable funds to be allowed and encouraged to invest in weapons.
Following a period of increasing geopolitical tension, the EU has been clear in its intention to increase defence spending, which will require backing by investors. This has caused mounting concern that the EU may choose to amend sustainable finance regulations – such as its taxonomy – to make it easier for ESG-labelled funds to invest in defence firms.
“When we consider the issue of weapons financing, which can be used for defence of democracy and human rights or for the invasion of countries and destruction of civilian lives and livelihoods, we need to talk about ethics far more than sustainability,” Phil Bloomer, Executive Director of the Business and Human Rights Resource Centre (BHRRC), told ESG Investor.
“Russia’s invasion of Ukraine is understandably driving EU expansion of its own defence capacity – but this expansion should compel the industry and the EU to deepen their ethical debate, especially regarding more indiscriminate weapons, like land mines and cluster munitions.”
There is no EU regulation that inhibits private investment in the defence industry, confirmed Thomas Regnier, Spokesperson for the European Commission.
“The EU recognises that the defence sector plays a vital role in enhancing sustainability – contributing to resilience, security, and peace,” he told ESG Investor.
“While some may argue that the inclusion of defence companies in sustainable finance is controversial, it is important to note that only weapons explicitly prohibited by international conventions are excluded.
“[F]or a truly transformative impact, we must move beyond partial exclusions and fully integrate defence-related initiatives into sustainable finance strategies,” Regnier said.
Minimum safeguards
Criteria under regulations like the EU Taxonomy – which outlines minimum safeguards to mitigate social harms such as human rights violations – imply that investment in the defence industry, which may contribute to civilian casualties, should not be considered taxonomy-aligned.
There is also potential for defence investments to fall foul of the Corporate Sustainability Due Diligence Directive (CSDDD), which requires organisations to monitor and address human rights abuses along its value chain, which could include borrowers or investees.
“CSDDD may currently exclude financial institutions for the next few years, but the companies they are invested in will be running substantial risks if their weapons and activities are associated with human rights violations like genocide and ethnic cleansing. Investors risk complicity,” added Bloomer.
He said sustainable finance regulations like the taxonomy and Sustainable Finance Disclosure Regulation should be clearer on the exact circumstances in which sustainable funds can invest in defence, noting that any ambiguity may risk increased exposures to firms that are big contributors to human rights violations and other societal and environmental harms.
In March, the European Commission published the European Defence Industry Strategy (EDIS) – a non-binding document outlining the policy direction for changes in the EU defence industry until 2035. This was published alongside the commission’s proposal for the European Defence Industry Programme regulation which will ensure the new strategy is implemented.
European NATO members’ defence spending has ticked up over the last decade, with annual increases averaging 3.4% since 2014.
But pressure has increased with the imminent return of President Donald Trump to the White House after he made clear the need for Europe to pay more toward its own defence in his first term. The EU is believed to be preparing to tap investors via a €500 billion (US$528.78 billion) defence fund.
Up for debate
The commission has been keen to support closer relations between investors and defence contractors. But this enthusiasm does not appear to extend to a discussion of the wider implications.
Tommy Piemonte, Head of Sustainable Investment Research at Bank für Kirche und Caritas (BKC), has claimed that the commission barred him from engaging in a public forum discussion on defence spending and how this intersects with sustainable finance.
Piemonte, also a representative for Shareholders for Change (SfC), attended the EU Defence Industrial Investment Forum last month, which was hosted by the European Commission’s Directorate-general for Defence Industry and Space (DG DEFIS).
He posed questions about the sustainability of the defence industry and the lack of due diligence around weapons exports. But these went unanswered and he was temporarily excluded for “disrupting” the public forum, leading to a formal complaint from SfC.
“From my perspective, the purpose of the event seemed to be focused on how to remove ESG hurdles to weapons financing and eliminate every critical voice that points out contradictions or wants to prevent this,” Piemonte told ESG Investor.
“The commission was clear that it does not foresee the EU taxonomy taking into consideration other regulations around defence [and that it] does not foresee a social taxonomy coming into play any time soon – probably not at all.”
The commission shelved developments for a social taxonomy back in 2022 – shortly after its Platform on Sustainable Finance, the expert group tasked with advising the commission on taxonomies and related policy projects, produced its final report on recommendations for a social-focused framework.
“Anyone who would like to invest in the defence industry is free to do that. A sustainable label is not needed to increase investment in the weapons industry,” Piemonte said.
“Clients will look at the integration of nuclear energy and gas [into the EU Taxonomy], the integration of weapons, and question what makes a sustainability-labelled fund any different from other vehicles.”
Despite this, sustainability-focused funds are increasingly open to investment in the defence sector.
In September, new research done for the Financial Times found that a third of EU and UK-based ESG-focused funds have invested €7.7 billion (US$8.08 billion) in the defence sector, up from €3.2 billion in the first quarter of 2022.
“The blanket exclusion of defence companies from sustainable funds based purely on revenue thresholds is counterproductive, particularly for small- and medium-sized enterprises in the sector, which are already facing significant challenges in accessing finance,” said Regnier for the commission.
Meeting halfway
If the defence industry is to be a viable option for sustainability-labelled funds, then companies need to demonstrate a willingness to prioritise sustainability, according to Bloomer from BHRRC.
“If the defence industry in Europe is prepared to improve its ethical and sustainable practices, then there is an argument to be made to include them in ESG funds – but we haven’t observed any such motivation at this point in time,” he noted.
Regnier said that the European defence industry must continue to reduce carbon emissions and promote circularity in line with EU sustainability goals, while ensuring the sector remains competitive and attractive to funding and talent.
He pointed to existing programmes such as the European Defence Fund and LIFE which are supporting these efforts.
As well as reevaluating existing sustainable finance regulations, Bloomer called on the commission to also consider the increasingly close relationship between the technology and the defence industries.
“Technology is now fundamentally part of weapons systems – from malicious surveillance systems and AI for targeting that create civilian loss of life, to the fog of propaganda and disinformation,” he said, asking for “clarity of purpose and legal certainty” in this area.
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