On the final days of 2025, the European Union quietly issued new guidance that significantly reshapes how defence investments are treated under its sustainable finance framework. The update clarifies which defence-related activities can be considered compatible with ESG-labelled funds, at a time when the bloc is seeking to mobilise up to €800 billion in defence investment over the next four years.

While defence financing was never explicitly excluded from the EU’s framework, the revised interpretation marks a notable shift in how weapons-related activities are assessed within sustainable investment mandates.

Redefining exclusion boundaries in ESG rules

Under previous guidance, ESG-labelled funds were barred from investing in companies involved in “controversial weapons.” The term, however, lacked precision and relied on broad references to international treaties, UN principles, and national legislation. This ambiguity created uncertainty for investors, ratings providers, and fund managers attempting to assess compliance.

In November, the European Commission approved a key wording change, replacing “controversial” with “prohibited.” This adjustment narrows the scope of automatic exclusions to weapons that are explicitly banned by most EU member states. These include anti-personnel landmines, cluster munitions, biological weapons, and chemical weapons.

Notably, nuclear weapons are not included in this list. While EU countries broadly support non-proliferation, only a small minority have signed the Treaty on the Prohibition of Nuclear Weapons. As a result, companies involved in nuclear deterrence programmes recognised under the Nuclear Non-Proliferation Treaty are no longer categorically excluded from ESG frameworks.

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What this means for defence-linked companies

The revised interpretation also affects materials and technologies that have long sat in ethical grey areas. Activities involving depleted uranium or white phosphorus, both controversial due to their military use and health impacts, are not classified as prohibited under EU law. This opens the door for defence contractors handling such materials to qualify for inclusion in ESG-labelled funds.

In regulatory terms, the change places greater discretion in the hands of asset managers, ESG ratings agencies, and index providers. Defence companies are now technically eligible for inclusion in Article 8 and Article 9 funds under the EU’s Sustainable Finance Disclosure Regulation, provided other criteria are met.

Market reality versus regulatory permission

Despite the regulatory shift, European ESG funds have so far remained cautious. Defence stocks are still largely absent from sustainable investment portfolios, reflecting ongoing reputational, ethical, and client-driven constraints. However, the latest guidance removes a formal barrier, signalling that defence and sustainability are no longer viewed as mutually exclusive at the policy level.

The timing aligns closely with broader EU efforts to scale defence spending amid heightened geopolitical risk. By easing ESG-related constraints, policymakers are effectively widening the pool of capital that can be channelled toward defence manufacturers without breaching sustainable finance rules.

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A broader signal for EU sustainable finance

The update highlights a deeper evolution within Europe’s ESG framework. What began as a system designed to steer capital toward environmental and social objectives is increasingly being adapted to accommodate strategic priorities, including security and industrial resilience.

With each revision, the debate around ESG shifts further away from ideology and closer to regulatory pragmatism. As disclosure requirements are softened and definitions refined, sustainable finance in Europe appears less about strict exclusions and more about flexibility in capital allocation.

For investors, the message is clear: ESG compliance is no longer solely about environmental or social outcomes, but also about alignment with evolving policy objectives. Whether this strengthens or dilutes the credibility of sustainable finance remains an open question, but for defence-linked capital in Europe, the door is now firmly open.

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