The new rules of engagement: ESG in defence investment

Global military spending reached US$2.88 trillion in 2025, the highest level ever recorded. NATO members account for 55 per cent of that total, and allied leaders have committed to spending up to 5 per cent of GDP by 2035. Capital is flowing into aerospace, defence and security. Investors, lenders and asset managers who might previously have stayed on the sidelines are now asking the same question: can I square defence investment with my ESG policies and mandates? 

A misconception worth retiring

There is a common misconception that ESG and defence investment are fundamentally at odds. That is not necessarily the case. A robust understanding of ESG factors can help investors define risk appetite, identify strategies to manage and monitor risk, and identify opportunities the sector presents, opening the door to investment rather than acting as an automatic bar to it.

Regulators in both the EU and the UK have reinforced this point. The European Commission has made clear that the EU’s sustainable finance framework is compatible with investing in the defence sector and its rules apply horizontally across industries and sectors. The UK FCA has similarly confirmed that its sustainability  rules do not prevent investment in, or financing for, defence companies, nor do they do not require financial institutions to treat defence companies differently to those in other sectors. The UN has also recently clarified, in relation to the arms sector, that the UN Guiding Principles on Business and Human Rights (UNGPs) do not suggest that all investments in the sector are necessarily inappropriate; rather, they provide a framework for assessing and addressing the risks and impacts connected to such investments and expect responsible business decisions that result in better human rights outcomes.

What matters most is appropriately scoped and well-documented due diligence and governance processes underpinning a structured and defensible approach to investment decisions and investment stewardship.

The importance of good governance 

Investors in the sector face a fast-moving ESG regulatory landscape, shifting stakeholder expectations and a volatile geopolitical backdrop. 

Key considerations to set investors up for success include:

• Strategy and governance. Whether there is a clear position on defence investment (subject to appropriate levels of senior approval and oversight), including how "defence" is defined; whether existing governance, exclusion and inclusion policies are fit for purpose; and whether the approach is aligned with any relevant client expectations.
• ESG risk management. Robust ESG due diligence on investees and on product end-use risks, taking into account recognised international standards, regulatory requirements and stakeholder expectations; active management of reputational risk; and a clear view on sovereign and political risk in relevant markets. 
• ESG and responsible investment. How defence investment sits alongside existing ESG commitments, policies and disclosures; how to factor in emerging frameworks such as the Guidance for Responsible Investment in Defence-related Companies (GRID); and readiness for increased disclosure requirements.
• Legal and regulatory compliance. Awareness of the sanctions, export control and other legal exposure that sits alongside policy/risk-based ESG considerations; how compliance as well as other legal and litigation risks are managed; and how the regulatory landscape and emerging legal risks are monitored.
• Futureproofing. Whether consideration has been given to future changes in investee circumstances, business model and deployment of products and associated governance (including early warnings and trigger points), controls and exit rights.

Emerging demand for industry approaches 

There is growing appetite for industry frameworks that can guide investors and signal to prospective investees where expectations lie. The GRID, currently being developed by a group of institutional investors and subject matter experts, builds on existing international frameworks and aims to give investors a principled way to navigate ESG considerations in the defence sector. A draft has been consulted on, and publication of the final framework is expected in November 2026. It is likely to emphasise the importance of robust risk management, including in relation to the potential misuse of defence products and exposure to conflict-related risks, alongside enhanced transparency and accountability across portfolios. 

Separately, the Global Advisory Alliance (GAA) has launched an initiative to bring investors into dialogue with selected European companies and ESG data providers on transparency in the defence and dual-use sectors. The initiative seeks to address consistency and quality gaps in the information available to investors, alongside revenue transparency, human rights due diligence, export and end-use controls, and AI-related safeguards. Pending sufficient investor participation, the GAA is aiming to start its first phase of engagement before year-end.

UN guidance notes, some of which are longstanding, also provide important insights into due diligence expectations and considerations, particularly where arms are concerned or where investments are made in or in relation to conflict-affected areas.

The bigger picture

This is more than a compliance exercise. Europe faces a significant defence financing gap that the European Commission estimates at US$1–2 billion in debt and US$1–3 billion in equity for SMEs alone. Investors who successfully embed ESG into their approach to the defence sector are likely to be better placed to value investments appropriately, manage reputational and legal risk, withstand stakeholder scrutiny, and keep pace with shifting regulatory expectations, as the defence sector continues to attract capital at a scale not seen in a generation.

For more information on the market dynamics, financing tools and wider legal issues shaping the sector, see our Aerospace, Defence and Security handbook: "A new era of hard power".