A leading British defence think-tank has warned that bureaucratic red tape, banks’ reputational concerns about funding defence, and the general characteristics of the defence market are the key factors limiting the sector’s access to finance rather than ESG.
The Royal United Services Institute (RUSI) was commissioned by UKSIF to carry out the independent research, looking at whether stalling defence growth can be attributed to ESG standards.
The report, which was written by Linus Terhorst, a research analyst at RUSI, said claims by defence company representatives that ESG is responsible for their difficulties in accessing basic financial services were “often unsubstantiated”.
It found that ESG labelling regimes and investors’ own practices generally do not preclude defence investment and “have little impact on the defence industry’s access to capital”.
While regulatory standards do not mandate defence exclusion, Terhorst said, investors’ in-house exclusion policies can create public confusion over how the sector fits within the reporting and labelling frameworks.
He added that the main limitations to growth in the defence industry are much wider, structural issues that limit its ability to attract investment, including export controls, late payments and dependence on political calculations for procurement decisions.
Terhorst noted that investors had not viewed defence as a growth sector in the past, which resulted in a marginal undervaluation and increased cost of capital, but this reluctance has eased under conditions of higher defence spending.
“The consequence of ESG-related exclusions on defence companies in the UK has been relatively unremarkable,” he said, noting that most industry experts agreed that the most direct impact was a small undervaluation.
Speaking to Responsible Investor, Terhorst said: “I don’t think any publicly traded defence company can complain about their cost of capital at the moment. The fact is that the key moderating variable of how attractive defence is as a sector for investment is not ESG regulations, it’s fundamental procurement behaviour from the various procuring nations.”
He added that, while some defence companies face difficulties accessing financial services, this was more to do with bank re-risking, regulatory requirements and reputational risk concerns than any ESG frameworks.
The report said there had been “unanimous” agreement across finance and defence experts consulted that instances of denying financial services to defence firms were not related to ESG reporting standards or sustainable investment approaches.
“ESG regulations are not the thing that invite Russia into Europe but there are more questions around how we do de-risking, how we deal with red tape, and how we can help the defence industry navigate that landscape,” Terhorst said.
Investors in the UK have come under significant pressure from both Conservative and Labour governments and lawmakers on the issue of ESG and defence investment.
In 2023, ministers in the Conservative government accused ESG investors of starving the industry of capital, and last year RI revealed the existence of a specially-established government taskforce on ESG and defence.
This year, more than 100 Labour lawmakers signed an open letter to financial institutions calling on them to rethink blanket sector exclusions. Two Labour MPs also wrote to the Financial Conduct Authority urging it to clarify how its rules interact with the sector.
Alex Baker, one of the two MPs, welcomed the publication of the RUSI report, commending its “focus on tackling financial barriers”.
“Without action, our innovators and local employers will continue to face unnecessary hurdles,” she said. “By recognising these challenges and setting out practical solutions, this report helps point the way to a stronger defence sector that can keep Britain safe and support prosperity in communities across the country.”
UKSIF CEO James Alexander said the report “draws a line under the notion that ESG standards are stopping capital from flowing into the defence industry”.
“This analysis shows that structural issues, such as complex procurement processes and long development cycles, are the main barriers to business growth, while SMEs face challenges complying with important international banking standards.”