The role of defence in sustainable finance is undergoing a major re-evaluation. Once excluded from ESG portfolios on ethical grounds, defence is increasingly being recast as a public good in the face of heightened geopolitical risks. European banks, asset managers, and regulators are moving to normalise investments in the sector, aligning national security with sustainability and financial performance.

Scope and Strategic Framework

In recent months, several major financial institutions have adjusted their stance on defence financing. French bank BNP Paribas relaxed its restrictions on controversial weapons, while Denmark’s Danske Bank expanded its investible universe to include an additional 200 defence-related companies. UBS Asset Management and Allianz Global Investors have followed suit, lifting bans that had previously excluded the sector from sustainable investment funds. The European Commission has also signalled support, estimating that €800 billion in new investments will be required for defence over the next four years. To mobilise capital, the Commission is clearing regulatory barriers, providing guidance on what counts as a sustainable investment, and streamlining eligibility for defence-linked financing.

Economic and Environmental Impact

The reorientation comes at a time when defence equities have significantly outperformed the broader market. Since Russia’s invasion of Ukraine in February 2022, Europe’s aerospace and defence sector has tripled in value, compared with a 20 percent increase across the wider European market. Morningstar data shows that Article 8 funds those classified under the EU’s Sustainable Finance Disclosure Regulation as promoting, though not primarily targeting, sustainability have quadrupled their exposure to defence since 2022. On average, these funds now allocate 2.5 percent of their portfolios to the sector, with more than half holding at least some defence stocks.

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Corporate Governance and Transparency

For financiers, the shift is not purely opportunistic. Defence is being reframed as a collective safeguard, particularly as the United States signals reluctance to shoulder Europe’s long-term security responsibilities. Investors increasingly argue that funding defence supports resilience, stability, and the protection of democratic systems — themes that overlap with governance and social dimensions of ESG. At the same time, questions remain about how to balance ethical considerations with financial performance. Critics argue that incorporating weapons into ESG strategies risks diluting the very definition of sustainable finance. The industry response has been to stress transparency, clearer classifications, and alignment with evolving EU guidance.

Challenges to Scaling

Despite the surge in interest, challenges loom. Ethical resistance to associating ESG with the arms industry is strong, particularly among investors with strict exclusion policies. Civil society groups continue to argue that destruction cannot be squared with sustainability, creating reputational risks for asset managers who embrace the sector. Moreover, overperformance may create concentration risks. Stocks such as Rheinmetall have already seen explosive growth, nearly quadrupling in value this year, raising questions about whether returns can be sustained. Investors face the delicate task of balancing near-term outperformance with long-term structural integration of defence into ESG portfolios.

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Future Outlook

With more than 110 armed conflicts active worldwide and decades of under-investment in European security infrastructure, momentum behind defence investment is unlikely to abate soon. Even in an improbable scenario where conflicts rapidly de-escalate, Europe will continue to channel both public and private funds into strengthening its defence capabilities. The fusion of ESG with defence marks one of the most controversial evolutions in sustainable finance to date. Yet the combination of geopolitical necessity, government policy, and market outperformance suggests that defence will remain embedded in ESG strategies going forward. For investors, the key challenge will be navigating the ethical debate while capitalising on a sector that has become both financially lucrative and politically indispensable.

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