Sustainability | ~ 3 min read
The case for defence
Following a review, and amid changing attitudes towards defence in Europe, we have evolved some of the defence-related exclusions in most of our sustainable funds.
The persistence of the conflict in Ukraine and emergence of other geopolitical developments have prompted a broader rethink of the resilience of Europe’s defence systems, compounded by the impact of a sustained failure of a number of European NATO members (plus Canada) to invest 2% of GDP into defence. The narrative of the critical need for robust defence and security is spreading – so too is the recognition that sustainability finance regulation could be a hindrance to this objective. Today, defence is more and more viewed as a necessity for socio-economic development.
We undertake annual reviews of our exclusion criteria to ensure ongoing conviction and relevance to our investment offering to clients. Last autumn, we initiated such a review on defence-related exclusion criteria for sustainable funds under the EU Sustainable Finance Disclosure Regulation (SFDR), engaging with key stakeholders. This review coincided with what we identified as changing attitudes towards defence within Europe, from government as well as regulators, and led us to evolve some defence-related exclusions in most of our sustainable funds.
It has been evident that two specific defence activity criteria were particularly onerous on the inclusion of Western defence companies in sustainable funds as classified under SFDR. The first was the 10% revenue threshold for military equipment and services, and the second was nuclear-related activities inside the Non-Proliferation Treaty (NPT). Major Western defence development and procurement is undertaken primarily through major publicly listed defence companies, compared to through state-owned entities for several other major economies. Many of these companies screen relatively favourably under different ESG and sustainability criteria.
It is our conviction that these two defence activity classifications are integral to a resilient and well-functioning defence and security system. Military equipment and services are critical to being able to defend oneself, and their reach typically extends to military personnel in conflicts. Nuclear weapons are a critical and credible deterrent to large-scale conflict and, in Western countries, the production of nuclear weapons is fully integrated into the industry and cannot be separated. We favour activities inside the NPT since the treaty promotes prevention of the spread of nuclear weapons and cooperation of peaceful uses of nuclear energy, with limits to activities. There are no such safeguards for nuclear weapons outside the NPT, which will remain outside the investment universe for our sustainability funds.
Other criteria will also remain in place. For the avoidance of doubt, we will still refrain from investing in companies that have a severe violation of international standards and/or international regulations. Nor will we invest in companies involved in controversial weapons such as biological & chemical Weapons, cluster munitions, anti-personnel mines, etc. Among those, there are controversial weapons that are not formally banned under international treaties, but which are being actively used and have long-lasting impacts on environments and civilians. These include depleted uranium and white phosphorus. Given the potential indiscriminate and long-lasting environmental and social harm, these activities remain excluded from sustainable funds under SFDR.
There is consensus that there will be a significant uplift of defence spend commitments by European NATO members at their summit in June. With fiscal budgets stretched in Europe, private finance will be required to meet the funding requirements. This is therefore a significant opportunity for private finance, including sustainable funds under SFDR, to direct the industry on which activities can be expected to be financed, to push for much-needed improved disclosures and supply chain transparency, and to consider innovative financing structures.
The structural shift in European priorities has turned the defence sector into the investment areas of growth, technology and thematics, and many of the new solutions and technologies reach into other core industries. There is an opportunity for defence to be a template for defining, governing and financing innovation in Europe, while also ensuring its safety and socio-economic development for coming decades.
Such reviews, and the decisions arising from them, are integral to our ongoing commitment to sustainability.
