The Evolution of ESG in the Defense Industry: Balancing National Security and Sustainability

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By ESG Analyst Steve Frantskevich

In recent years, the defense industry has found itself at the crossroads of a significant debate: can it align with ESG principles while maintaining its critical role in national security? This question has become particularly pressing in the wake of geopolitical tensions and increasing investor scrutiny. 

Changing Perceptions: From Exclusion to Integration 

Before the war in Ukraine, defense companies faced dwindling interest from institutional investors due to ESG concerns. Despite the sector’s profitability, the number of institutional investors declined influenced by the public’s negative perception of the industry. However, the onset of the war in Ukraine in February 2022 marked a turning point. Public perception shifted, and interest among institutional investors in the defense sector resurged. According to a recent study, the number of institutional investors in the 16 major defense companies increased by 6% in 2022, with further growth anticipated going forward. The industry also saw a record industry revenue of $829 billion in 2023, growing 11% from the year prior.   

This change in sentiment underscores a critical question: Can defense companies align with ESG investments? The defense sector is traditionally viewed through a lens of ethical concerns but now it benefits from a more nuanced understanding of its role in preserving peace and stability. The recognition of national security’s importance, in addition to the defense sector’s role in upholding democratic values and human rights, have contributed to this shift. 

The Role of ESG Criteria in Defense Investment 

Institutional investors typically rely on specific ESG criteria to guide their investment decisions. These criteria are classified into three categories based on their potential for improvement within the defense industry: 

  1. Hard-to-Abate Criteria: These are criteria that are inherently challenging for defense companies to meet because they involve fundamental aspects of their operations, such as the production of controversial weapons or reliance on nuclear energy. 
  1. Medium-to-Abate Criteria: These criteria can be potentially met by altering specific practices, such as reducing carbon emissions and avoiding business with non-democratic countries. 
  1. Easy-to-Abate Criteria: These universal criteria emphasize ESG-compliant business practices, such as carbon emissions disclosure and addressing general ESG issues throughout the value chain. 

Embracing ESG in the Defense Sector 

For defense companies to improve their ESG compatibility, they must adopt a multi-faceted approach. This includes defense-specific measures, defense-related measures, and general ESG measures: 

  • Defense-Specific Measures: These challenge central elements of a company’s value proposition and include actions like adjusting product portfolios, focusing on defensive technologies, and moving away from products using conflict materials. 
  • Defense-Related Measures: These alter defense-related practices and include formulating codes of conduct, creating ethical assessment frameworks, and increasing transparency in decision-making. 
  • General ESG Measures: These ensure overall ESG expectations are met and include improving communication on positive ESG impacts, focusing on environmentally friendly products, and implementing renewable energy usage. 

Government and Industry Responses 

Governments and industry leaders have also begun addressing the intersection of ESG and defense. The UK government has committed to protecting its defense companies from ESG investors who might seek to defund them. UK Secretary of State for Defence Grant Shapps emphasized the moral imperative of investing in defense, citing the need to challenge tyrannical activities and uphold national security. 

Similarly, NATO Secretary General Jens Stoltenberg highlighted the ethical necessity of the defense industry, particularly in supporting Ukraine’s defense against aggression. The European Defence Agency (EDA) Steering Board echoed these sentiments, warning that excluding defense companies from ESG indices has negative consequences, including limiting investment opportunities and damaging the industry’s reputation. 

Public-Private Collaboration and the Future of ESG in Defense 

The evolving landscape has encouraged discussions on public-private collaboration to meet national defense requirements. Reports, such as the one from the United States Studies Centre at the University of Sydney, stress the importance of integrating private finance with national security efforts. This integration is crucial for leveraging private sector capital in defense capabilities and infrastructure. 

In Australia, initiatives like the Treasurer’s Investor Roundtable have brought together leaders from major asset owners, managers, and venture capital firms to explore investment opportunities in defense and social impact projects. Such efforts aim to unlock investment in defense infrastructure and technologies, highlighting the role of dual-use products with civilian and military applications. 

Future Outlook 

The defense industry’s journey towards ESG integration is complex but increasingly necessary. As public perception shifts and investor interest grows, defense companies must adopt comprehensive ESG strategies. This includes addressing specific defense-related issues, complying to general ESG principles, and engaging in public-private collaborations. By doing so, the defense industry can enhance its ESG performance, secure future capital, and continue to play a vital role in promoting global peace and stability. This evolving narrative demonstrates that ESG and national security are not mutually exclusive but can coexist to create a more sustainable and secure future. 

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