Security spending prompts sustainable rethink
Security is at the top of the global agenda in a period of heightened geopolitical instability and conflict and could change the path of sustainable finance – if investors warm to the idea.
It is the top priority in European policy as the continent moves towards greater independence in areas including defence, technology, resources and energy, which requires significant capital.
While a strong case for a rapid transition to a net-zero economy still stands, the focus is on increasing locally produced energy, protecting sources from physical or cyberattacks and securing resources for electrification and transmission.
"Avoiding any disruption of supply is taking more priority than replacing the old energy supply with a new one as fast as possible," said Thomas Thygesen, head of X-asset strategies at SEB Merchant Banking.
That requires a rethink in sustainable finance; reframing some defence spending as a resilience issue could also help to overcome any practical and psychological hurdles.
"The focus is on a much more integrated, holistic understanding of sustainability that includes issues such as the resiliency of vulnerable infrastructure and cybersecurity. The spectrum must be much broader," said Gregor Vulturius, lead scientist and senior adviser on climate and sustainable finance at SEB.
The European Commission's ReArm Europe Plan/Readiness 2030 aims to mobilise €800bn in defence investment, leveraging €150bn in NextGenerationEU loans.
The European Investment Bank is also significantly increasing its support and is providing €9.1bn with the European Investment Fund to strengthen Europe's security and defence capabilities, technological leadership and critical infrastructure.
Aligning security infrastructure with low-carbon energy could mean the whole energy infrastructure are seen as potential sustainable investment, such as grids and battery storage.
"Many funds would like to participate in replacing the grid, providing storage and protecting clean energy supply from cyber and hybrid attacks. There's a lot here that the EIB could potentially label with a sustainable finance label," Thygesen said.
The sustainable debt market could see new ESG-labelled deals for security in the very near future.
"Hardening existing infrastructure to deal with security threats should be happening right now," said Sean Kidney, CEO of the Climate Bonds Initiative. "We could very feasibly see some ESG financing directed towards security in the next few months."
However, many practitioners and investors are adamant that the green, social and sustainable labels should be kept for the purpose for which they were intended, with clearly defined uses of proceeds.
"There's certainly a strong pushback in the sustainable finance community around allowing all of this spend to be badged up to somehow be sustainable," a senior ESG banker said.
Reframing the debate
Many ESG investors have defence exclusions in place that they are now trying to reword or lift as defence spending increases although regulatory recommendations remain contradictory.
On average, around 18% of Article 8 funds, and 0.2% of Article 9 funds invest in defence-related companies, according to research by ABN AMRO.
"Sustainable finance investors have to face the fact that they are competing with and probably overpowering social economic priorities right now. It's about finding the synergies with these priorities and with your own sustainable finance mandates or goals or targets," Vulturius said.
European law allows ESG funds to invest in defence-related companies if certain conditions are met, but the European Securities and Markets Authority prohibits funds with ESG in their name from investing in controversial weapons.
Investments in defence companies appear to be misaligned with social objectives outlined by Europe's Sustainable Finance Disclosure Regulation.
However, the European Commission has said the defence industry enhances sustainability through its contributions to resilience, security and peace, and clarified that no rule under the EU sustainable finance framework restricts private investments in the defence sector.
French regulator AMF last month called for the European Commission to consider a specific category for European defence products within the Sustainable Finance Disclosure Regulation.
"We've got to think through these issues – we have a chance to do so but it's a live issue and it's an urgent issue," Kidney said.