FE fundinfo's Helen Slater: ESG's defence debate hinges on transparency

Clearer disclosure will be key

This article featuring Helen Slater, Regulatory Manager at FE fundinfo, was published in Investment Week on 5 June 2025

When the Financial Conduct Authority clarified earlier this year that ESG rules do not restrict investments in defence, firms received a clear signal any long-held investment taboo in the sector was now up for question.

Similar guidance from the European Commission last October has further contributed to this broader debate within investment circles: can defence be compatible with ESG?

It is no longer an abstract question. Within the context of shifting global security, the war in Ukraine and economic volatility, the industry has somewhat shifted its perceptions of security.

Defence, once a fixture on exclusion lists alongside tobacco and fossil fuels, is now being examined through a new lens: one that considers national security, democratic resilience and geopolitical responsibility as ESG-aligned objectives.

Shift from blanket exclusions

Historically, ESG frameworks were grounded in ethical exclusion. Defence firms were ruled out categorically, often with little differentiation between conventional military suppliers and those involved in controversial weapons.

However, major shifts in the global security context mean ESG is evolving into a framework that can include new criteria such as impact performance metrics and systemic risk considerations.

This evolution opens the door to a more layered interpretation of what counts as ‘sustainable'. For some asset managers, defence can be viewed as a stabilising force that safeguards civil institutions, humanitarian operations and even environmental conservation in conflict zones. Yet this shift does not come without complications.

Opportunities steeped in risk

There is no ignoring the ESG risks tied to the defence sector. Human rights concerns, carbon emissions and supply chain opacity all apply.

Reputational risk is particularly acute for institutional investors and pension funds, whose stakeholders may have strongly held views on the ethics of weaponry, regardless of its use.

Yet the binary exclusion of the entire sector has its downsides. It prevents engagement with companies on sustainability issues, forfeits the opportunity to influence responsible practices and may sideline a sector increasingly relevant in a volatile world. It also overlooks the fact many European defence firms operate within strict legal and ethical boundaries, focusing solely on conventional defence systems.

Disclosure at the core

If ESG frameworks are going to stretch to accommodate defence, then the burden must fall on clearer communication.

Asset managers should be upfront about whether their portfolios include defence exposure, what kind and under what conditions.

Disclosure should not be limited to the fact such holdings exist, but also why they meet sustainability criteria, what screening is applied and whether there are exclusions for controversial weapons or governance risks in end-user countries.

The onus on managers should be to outline what standards they apply in order to determine acceptability.

The same principles apply to ESG ratings, where transparency is especially critical given the disparity across the industry. Some providers give high marks to defence companies based on governance practices, while others penalise the sector categorically.

These inconsistencies could leave investors confused, or worse, misled.

An ESG-labelled fund cannot credibly claim sustainability credentials while holding companies whose core outputs contradict those principles, unless it can clearly articulate the rationale.

From taboo to transparency

This conversation is unfolding against a political backdrop of growing urgency. In Brussels, Paris and London, policymakers are reconsidering the role of ESG in funding Europe's defence infrastructure.

There are proposals that sustainability funds be encouraged, or even expected, to allocate capital to defence, framing it as a strategic necessity in an era of global uncertainty.

But while governments can frame the debate, it is asset managers who must resolve the alignment challenge.

ESG is, at its core, a communication contract between asset managers and clients. Rather than picking a side in a moral debate, managers should focus on being transparent. If a portfolio includes defence exposure, spell it out: explain the rationale, define the boundaries and make sure it aligns with the fund's stated objectives.

Ultimately, ESG's credibility rests on consistency. Managers do not have to agree on defence, but they do need to be clear, considered and accountable in how they approach it.

We are moving away from blanket exclusions to a more nuanced approach that considers a variety of factors to see where it fits into sustainability criteria. Defence might no longer be taboo, but a clear view as to what lies beneath the label is key to ensuring moral and operational risks are handled adequately.

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Helen Slater, Regulatory manager, FE fundinfo