In a remarkable announcement late last year the UK government made a commitment “to defend” its defence companies “from environmental, social and governance investors trying to immorally defund British defence”.
UK Secretary of State for Defence Grant Shapps said “investment in defence is the morally right thing to do, without which the atrocious activities of tyrants like [President of Russia, Vladmir] Putin would go unchallenged and undeterred”.
Shapps’ comment followed his ‘Defence Industry and Environmental, Social and Governance Considerations Statement’ to the UK parliament where he claimed UK defence companies were being excluded from access to debt and equity capital on ESG grounds despite them being “essential to protecting our way of life”.
Elsewhere, addressing the NATO-Industry Forum in Stockholm in October, Secretary General Jens Stoltenberg (pictured below) said while some investors “have the misguided idea that the defence industry is somehow ‘unethical’”, there was nothing unethical about defending allies or helping Ukrainian soldiers to defend their country.
“Indeed, without industry, there is no defence, no deterrence and no security,” he said.
A few weeks later the European Defence Agency (EDA) Steering Board – which comprises the defence ministers of the European Union – said: “The fact that many ESG [indices] exclude companies with activities in the defence and armaments sector has wide-ranging negative consequences for the defence industry, such as limiting the number of potential institutional and private investors, damaging its reputation, and making it harder for the industry to attract talent.”
The steering board (pictured below) said “ongoing efforts to increase the sustainability of Europe’s economy and industry cannot come at the expense the resilience and competitiveness of the ‘European Defence Technological and Industrial Base’ (EDTIB) as well as the overall security of the EU and its citizens”.
In its recent report ‘Upscale: Using Private Sector Capital For The Alliance’, the United States Studies Centre (USSC) at the University of Sydney explained that “in northern hemisphere financial capitals, Russia’s invasion of Ukraine in 2022 has spurred a more nuanced and realistic discussion about ESG constraints on investment in defence firms and defence-related activities given the new security challenges facing free and open societies”.
The report said: “With the rise of ESG investing, the place of defence industry including companies in defence supply chains and technology companies has received increased attention, especially given the pressures for greater defence spending by Western democracies.”
These issues and “investment dynamics such as the rise of ESG investing can no longer be of merely passing interest to defence planners and policymakers”, it said. “They impact directly on Australia’s capacity to meet national defence requirements including the ability to field technically advanced capabilities.”
The report argues that “if Australia is to approach the sort of “whole-of-nation” effort called for by the Defence Strategic Review the worlds of private finance and national security need to be joined up”.
No doubt partly with such an aim in mind, the chiefs of Australia’s biggest asset owners, asset managers, banks and venture capital firms were invited to Canberra in December for the third Treasurer’s Investor Roundtable.
The gathering (pictured below) discussed the net zero transformation, defence and social impact investment with a view to “identifying and unlocking investment opportunities that are in the national interest and that deliver strong returns to shareholders, members and the broader community”, according to the government.
Among the attendees were the bosses of AustralianSuper, ART, CareSuper, Cbus Super, HESTA, HostPlus, Rest, Unisuper and IFM Investors.
The government said it would identify and assess options to partner with private capital to invest in Australian SMEs that are developing defence capabilities and that expressions of interest from investors to participate in a defence investment fund will be sought this year.
As part of its response to the DSR, the government said it would also “consider opportunities to invite private capital to invest in defence infrastructure and technologies”.
Working groups with investor participation are also being established to address barriers to investment in defence as well as net zero transformation and social impact projects.
Minister for Defence Industry Pat Conroy said there was the opportunity for institutional investors “to be involved in the production of world‑class defence technologies and platforms, presenting an opportunity for everyday Australians to have a stake in the defence of their nation”.
Dual-use and infrastructure
The USSC report says areas for deeper public-private collaboration should include dual-use technology companies and start-ups with products and services at mid- to late-stage development and also defence infrastructure and infrastructure-like projects offering investors stable, long-term rates of return.
Some Australian super funds already have experience in contracting with the Defence Department on infrastructure projects. IFM Investors, for example, has operated and maintained the Headquarters Joint Operations Command (HQJOC) base near Canberra in partnership with the government since 2008.
Dual-use products (i.e. those that have civilian as well as military applications) are more attractive to private sector investors, meaning the government is more likely to be able to leverage private finance.
However, dual-use companies are also problematic. The European Investment Bank, for example, will only support dual-use products and technologies if most of a company’s revenue comes from civilian applications.
ASX-listed Droneshield offers dual-use counter-drone products and solutions such as remote drone detection, tracking and jamming technology.
In a recently-published opinion piece, Droneshield CEO Oleg Vornik said it was vital that “Australia’s fund managers and investor community take an active role in supporting the local defence industry, as that ultimately supports our rules-based order and way of life”.
“Unfortunately, misconceptions about the suitability of defence companies to investments increasingly underscored by ESG policies has blocked ample funding funnels from reaching these organisations,” he said.
Vornik lamented that “defence companies are brushed aside – frequently equated to heavy carbon emitters, tobacco, pornography, or similar ESG red flags”.
“The situation could become more dire amid the introduction of tighter ESG rules and regulations for investors globally,” he said.
However, DroneShield said it is receiving strong support from both Australian and US governments. Last month, $10.4 million worth of DroneShield’s counter-drone equipment was selected for deployment to Ukraine under the latest Australian Government aid package.
As further evidence of this support Droneshield issued a press release late last year to announce that Australia’s Prime Minister Anthony Albanese “was recently pictured with one of DroneShield’s products… during a visit to the White House”. The picture is now used in its investor presentations (see below).
UK Defence ESG Charter
In an effort to demonstrate they are taking ESG seriously, UK defence trade association ADS and defence companies Airbus, Babcock, BAE Systems, Leonardo, MBDA, QinetiQ, and Thales announced in late January they were the initial signatories to a UK Defence ESG Charter.
ADS said “the UK defence sector believes that sustainability and national security are intertwined imperatives and is actively responding the challenges of climate change and broader sustainability issues”.
The charter makes various high-level commitments across three areas: climate transition and cleantech; societal impact; and governance and ethics.
Climate and security nexus
There is a lot more at stake here than whether a particular defence company or project should qualify for inclusion in an ESG fund or portfolio – or whether the definition of ESG should be tinkered with to facilitate this.
Last year the European Commission released a communique, ‘A new outlook on the climate and security nexus: Addressing the impact of climate change and environmental degradation on peace, security and defence’. It said the EU “must make further progress in addressing the linkages throughout the whole-conflict cycle between the climate and environmental crises, peace and security, in line with the EU’s Integrated Approach”.
Investments in climate and the environment should be seen as investments in peace and security and the impact of armed conflicts on the environment need to be acknowledged and addressed.
Single security space
The Stockholm International Peace Research Institute says “the world is facing a wide range of security risks, many of them non-military in nature”.
It says that “the idea that military-led security, ecological security and broader human security comprise a ‘single security space’” is being increasingly recognised.
The institute says “many national security strategies already reflect this more holistic understanding”.
“Alongside military threats and related priorities they list issues such as climate change, food and energy security and economic security,” it says.
A recent update from the UN Advisory Board on Disarmament Matters calls for states to develop a more holistic approach to security that would “see fewer resources allocated to competitive arms acquisition and more to actions that meet the needs of peoples and the planet, such as mitigating climate change and reducing socio-economic inequalities”.
In such a world the defence industry might start to look more like a sustainable investment proposition.