Given the unpredictability of re-elected U.S. President Donald Trump’s policy toward European security, defense ministers of five European countries issued a joint statement on January 13 in Helenów, Poland.
The statement by five nations – France, Germany, Italy, Poland, and the UK – said that “a strong European defense industry and supply chains will form a crucial component of deterrence. We encourage our domestic industrial sector to cooperate, engage, and collaborate with the Ukrainian defense industry in order to create synergies and to improve the standards and production, which are instrumental to enable their self-defense and contribute to peace and stability in Europe”.
However, defense experts are worried whether these defense ministers could convince the European policymakers to suitably modify their environmental, social, and governance (ESG) guidelines established by ESG-compliance frameworks and regulatory bodies that have considerably crippled the functioning and output of the European Defense Industry. There are serious constraints due to what is said to be the “ethical” side of weapons financing.
There are not enough investors for the European defense industry unless they segregate their civil-sector activities (which can be listed for trading) from their military-sector activities.
This is hitting Europe’s small and medium-sized defense companies, which are struggling to access the finance needed to drive innovation and grow production lines even as demand soars due to the war in Ukraine and other conflicts.
ESG guidelines are said to be much stronger in Europe than in the United States. That is possibly one of the reasons why the gap between American defense companies and their European counterparts has widened in recent years.
Though after Ukraine was invaded, European nations increased their defense expenditure, Europe still accounts for just 20% of defense sector spending worldwide as against America’s 42 percent.
In its report released last week, Morningstar Inc., the American financial services firm headquartered in Chicago, said that though over the past three years, European countries have significantly increased defense spending as a percentage of GDP, in 2023, all EU countries remained behind Russia and the US (except for Poland), with only 10 of 27 countries reaching NATO’s 2% threshold.
According to Landscape, European Defense underwent “30 Years of underinvestment”. During the Cold War, European nations typically spent about 3% of their GDP annually on defense. This changed in 1992, when the perceived threat decreased with the Soviet Union’s collapse, leading many countries to significantly cut their defense budgets and reallocate funds to social programs.
In 2014, following Russia’s annexation of Crimea, NATO allies committed to spending at least 2% of their GDP on defense and dedicating over 20% of their defense budgets to new equipment and R&D. Despite this commitment, most countries have consistently failed to meet these requirements.
Incidentally, the underinvestment in European defense is formally known as “the Peace Dividend.” The Landscape report calculates that the Peace Dividend has resulted in US$1.8 trillion Underinvestment. “From 1992 to 2022, European countries spent approximately US$5.7 trillion on defense, 49% less than what would have been spent if they had maintained their average Cold War expenditure rates. When comparing this actual expenditure with a scenario where 2% of GDP was consistently spent on defense, the resulting peace dividend totals US$1.8 trillion, marking a 25% reduction”.
Here, the ESG guidelines are said to have played an important role, magnifying the defense sector’s substantial environmental impact — from resource-intensive manufacturing to operational emissions — on the one hand, and asserting human rights issues and ethical standards across complex, global supply chains.
All told, defense companies do have adverse environmental impacts, given their fossil fuel-dependent operations, which are believed to contribute more than 5% of global emissions.
Business ethics is said to be another major ESG risk, particularly in human rights, as complex supply chains often rely on raw materials from conflict-affected regions where forced labor and abuses are common.
All this has resulted in private and institutional investors being extra careful when investing in European defense stocks and companies. So much so that the European Defence Agency (EDA), set up to organize the EU’s defense capabilities across member states, said last November that investment decisions from the finance sector were “subject to increasingly stringent ESG criteria.”
The EDA pointed out that the regular exclusion of defense firms “has wide-ranging negative consequences” for Europe, such as closing off the defense industry to talent, curtailing the number of potential investors, and damaging the sector’s reputation.
Apparently, a 2024 European Commission report has estimated that small- and medium-sized enterprises (SMEs) in the EU’s defense sector faced a debt financing gap of between 1 billion euros (US$1.03 billion) to 2 billion euros (US$2.06 billion), crimping business growth, forcing firms to reduce operations and search for funding outside the European Union.
Overly stringent and cautious interpretations of ESG criteria often result in exclusion policies by banks and investment funds in the EU, the report said, adding that providing clarity to the financial sector on how to address sustainability risks could improve access to financing.
“In a sector defined by long development cycles and large capital requirements, a lack of funding can hamper a company’s ability to innovate, expand, or even maintain its current operations,” the report found.
Unlike bigger enterprises that tend to be listed on stock markets and benefit from exposure to larger global markets beyond Europe, many defense experts argue that smaller, more highly specialized companies can present a greater risk as they tend to be more component or system-based. Therefore, the EU report has recommended providing EU-level funding to develop the bloc’s defense industrial capacities and removing restrictions on access to EU-funded financial instruments.
In the wake of the Russian invasion of Ukraine, many European defense companies are now arguing that Europe should recognize their strategic role in maintaining security and protecting freedom.
In any case, now there is an emphasis on reevaluating the term “weapons” while applying ESG norms. As it is, investments in European companies have been judged as to whether they are producing “controversial” weapons prohibited by the Oslo Convention on Cluster Munitions (2008) and the Ottawa Anti-Personnel Mine Ban Treaty (1999). But these weapons have now been allowed to be used in Ukraine. The U.S. has provided cluster munitions and sent anti-personnel land mines to Kyiv.
Some defense companies are expecting a shift in perception towards the categorization of weapons by the European Regulatory Platform on Sustainable Finance’s Social Taxonomy, set for legal adoption in 2025. Reportedly, this platform specifies that only controversial weapons (for example, nuclear, chemical, biological) are socially harmful and excludes defense activities like aircraft, vehicles, ships, engines, electronics, and cybersecurity.
The point is that European legal regimes recognize the strategic importance of safeguarding a free society from conflicts and aggressions. In this sense, it is argued that President Trump’s transactional approach to military aid to Europe and his call for increased NATO defense spending could drive higher EU defense spending, benefiting European contractors.
- Author and veteran journalist Prakash Nanda is Chairman of the Editorial Board of the EurAsian Times and has been commenting on politics, foreign policy, and strategic affairs for nearly three decades. He is a former National Fellow of the Indian Council for Historical Research and a recipient of the Seoul Peace Prize Scholarship.
- CONTACT: prakash.nanda (at) hotmail.com
