EU Member States ask EDA to take a role in helping open up access to finance for defence
Imagine you are running a medium-sized defence company in northern Europe. A large, nuclear-armed adversary has just attacked its democratic neighbour, bringing the biggest war since 1945 back to your borders. Much of the world is in shock. Politicians, citizens and allies naturally look to you and your peers to dramatically ramp-up production, possibly even moving to a war footing. All the talk is of capabilities, equipment and ammunition.
But when you go to one of your financiers for credits and guarantees, you find that your longstanding business relationship has been cancelled. Another bank says you can only maintain your account for payments and transfers, but that you cannot enter into any new credit relationships. A third says you must prove your business is sustainable and show that less than 10% of turnover comes from weapons to be eligible for new loans.
As contradictory as it might seem, investing in defence contractors is seen as taboo even as Member States provide massive financial, humanitarian and military aid to Ukraine and EU citizens give Ukrainians refuge in their homes following the outbreak of Russia’s unprovoked war of aggression against Ukraine in February 2022.
In anonymous testimonies, many defence companies have said they found that they were lumped with tobacco, pornography, alcohol and gambling by private investors looking to avoid unethical business.
The European Defence Agency (EDA) is now part of high-level efforts to raise awareness about the need to support defence companies, even as banks seek to respect so-called Environmental, Social and Governance (ESG) criteria. The question remains: can defence companies reconcile compliance with sustainability goals while securing long-term funding for European security, or should they be exempt?
NATO Secretary General Jens Stoltenberg is clear. Addressing the NATO-Industry Forum in Stockholm in late October 2023, he argued there was nothing unethical about defending allies or helping Ukrainian soldiers to defend their country. “Indeed,” he said, “without industry, there is no defence, no deterrence and no security.” So the argument goes in other European capitals: peace needs defence, and defence needs an industrial base. To many following Russia’s invasion, the military is now seen as more morally acceptable.
€160 billion catch-up
Banks and investors might be forgiven for having passed over defence companies in the past. Before Russia’s war of aggression in Ukraine, the European Defence Technological and Industrial Base (EDTIB) was running in peacetime mode following the end of the Cold War. Defence budgets were slashed after the 2008 global financial crisis.
Employing some 460,000 people and generating €180 billion a year in turnover across the EU, the defence industry’s size pales in comparison to, for example, the agricultural sector that generates over €420 billion a year, with 8 million jobs, according to a study by the French National Assembly in 2022.
What’s more, a casual observer might conclude that the European defence industrial base has plenty of access to financing, through public funding mechanisms. As much as €8 billion from the EU budget is dedicated to the European Defence Fund for 2021-2027. The European Commission has also opened up €468 million in grants to boost defence production under the new Act in Support of Ammunition Production (ASAP).
But there is a lot of catching up to do. Between 2009 and 2018, the sharp defence spending cuts meant an underinvestment of around €160 billion during that time, according to EDA data.
Still the defence industry plays a unique role. By producing the capabilities and equipment that both the EU and its partners need, the EDTIB is a contributor to Europe’s overall security, stability, resilience, and competitiveness. EDA believes Europe’s future competitiveness in research and development (R&D), and innovation, stems in part from the defence industry. In addition, the green transition and meeting ESG criteria can never come at the expense of the operational effectiveness of European armed forces and the security of citizens.
Alphabet soup and the 2008 crash
Since the 1960s, there have been efforts to recommend ways for the financial sector to include environmental, social and corporate governance issues to redirect capital.
Promoting sustainable finance has built up gradually since 2004, when the United Nations first publicly communicated the idea of ESG. Academics point to the forerunners of corporate social responsibility (CSR) for investors, and socially responsible investment (SRI) for companies. These led into ESG. But ESG has never been standardised and ratings vary in the United States and Europe, according to a September 2022 study by Laure de Roucy-Rochegonde and Amélie Férey at the Institut français des relations internationales. An EU ‘Ecolabel’ also aims to help EU savers navigate the labyrinth of ESG products.
The European Commission has sought to standardise ESG criteria across the EU. This is in support of the EU’s Green Deal, which aims to help the bloc achieve climate neutrality by 2050. The plan takes “a tri-fold approach which sees the creation of an environmental taxonomy, the extension of the Ecolabel to retail financial products and a proposal for the establishment of what is being called social taxonomy,” Roucy-Rochegonde and Férey write.
Sustainable finance, in fact, dates from the 1700s and has its roots in religious philanthropic movements such as the Quakers in Britain, points out Sylvie Matelly, Deputy Director at the Institut de Relations Internationales et Stratégiques, in a March 2023 policy paper for the Armament Industry European Research Group.
“The change came from the financial crisis in 2008 when the demand of small shareholders for ethical investments met the desire of banks and funds to restore their image,” Matelly writes. From 3% of total assets before 2008, ethical investments now represent nearly 30% of financial assets in Europe and the United States, she states. That could reach 50% in 2050, according to the European Sustainable Investment Forum.
The defence industry is so far not included in the environmental and taxonomies. However, EU defence experts worry about the message they send to banks who anticipate more regulations for defence and have begun to self-regulate.
Raising awareness
With so much at stake, EDA’s first step might seem relatively modest by helping to ensure a political statement at the EU level. But it is about raising awareness. Ministers of Defence, with EDA’s help, are endorsing a view that the European defence industrial base must not be overlooked.
The task to develop this statement was given by Member States’ National Armament Directors in March 2023, following the Agency’s ESG Action Plan of the year before, in March 2022, which sets the framework for EDA’s activities on this topic.
For now the goal is to:
• Ensure EU level policies that facilitate access to finance for defence companies
• Continually call on private and public financial institutions among Member States to stop discriminating against the EDTIB in their internal policies
• Allow EDA to continue monitoring developments in this field, and provide a follow-up plan for implementing principles.
Besides the statement, the ESG Action Plan has already enabled EDA to set up a Governmental Expert Network on ESG. Within the network, government experts and representatives of the European Commission discuss ways of supporting industry’s access to finance as well as meeting ESG criteria. The network has also served to meet financiers to better understand their reluctance as investors in the defence sector.
‘You’re such an asset’
In essence, the European defence industrial base needs to be competitive and resilient enough to support the EU’s national armed forces.
Armed forces are also part of the transition to a greener economy as they reduce their carbon footprint. Surely it would be better for investors to help fund the defence sector so that it can achieve an energy transition? Examples include developing biofuels, electric military vehicles and reducing the energy loss of its installations.
For EDA, in support of European defence ministries, the transition rests on three interlinked pillars: the Consultation Forum for Sustainable Energy in the Defence and Security Sector, also known as CF SEDSS; the Energy and Environment capability technology group (EnE CapTech); and the Incubation Forum for Circular Economy in European Defence, or IF CEED.
One line of argument is that the defence sector should not be seen as a conventional sector of the economy, given the role it plays in a country’s security. If agreed by EU governments, a change in the lending and investment policies of public banks, possibly including the European Investment Bank (EIB), towards the defence sector, would also reflect that point of view.
Investment standard-setting is, by design, slow-moving and deliberate. A global endorsement of defence will not come quickly. But views are changing and clarity is emerging. In March 2022, EU leaders agreed that “measures should be taken... to promote and facilitate access to private funding for the defence industry”.
To that end, the work of EDA, EU governments, industry and the European Commission is on a sustainable footing.