Commonwealth_Europe) Top trade bodies for the UK‘s financial services and defence sectors have come together to develop a comprehensive wishlist of policy reforms aimed at directing more debt financing and equity capital into the country’s defence industry. The collaboration was driven by the broader context of increasing rearmament initiatives across Europe, following the start of the Russia’s – Ukraine war, and rising concerns that Europe can no longer rely solely on U.S. protection. These reform proposals were crafted by TheCityUK, UK Finance, and ADS Group, which represent some of the largest finance firms and key players in the defence industry.
British Prime Minister Keir Starmer recently pledged to increase the UK’s annual defence spending from 2.3% to 2.5% of GDP by 2027, with aspirations to push it to 3%, a level not seen since the aftermath of the Cold War. In parallel, German lawmakers have pushed for a radical overhaul of borrowing rules to fund military initiatives, while the European Commission signaled its willingness to borrow up to 150 billion euros to support EU governments in their rearmament efforts. These moves reflect a growing sentiment across Europe that heightened defence spending is crucial in the wake of geopolitical tensions.
The financial entities involved in the effort, including some of the UK’s largest institutions such as HSBC, Barclays, and Legal & General, along with defence giant BAE Systems, aim to address regulatory hurdles that may limit the ability of banks and investment firms to support arms manufacturers. As part of their joint initiative, the groups plan to submit policy recommendations to Britain’s Business Minister Jonathan Reynolds. Their proposed measures seek to tackle various “friction points” that hinder financing in the defence sector. Key proposals include facilitating better risk-sharing practices between financial institutions, ensuring faster payments to smaller companies within defence supply chains, and providing clearer regulatory signals to assure investors that defence investments are compatible with Environmental, Social, and Governance (ESG) criteria.
David Raw, the Managing Director of Commercial Finance at UK Finance, recognized the intricate nature of the regulatory landscape and underscored the absence of a universally applicable solution. A report released in December 2023 by UK Finance and ADS highlighted 10 international frameworks that influence the availability of finance for the defence and security sectors. These frameworks can sometimes create additional challenges for banks and investors when navigating the sector’s intricacies.
One of the key challenges identified is the reputational risk that banks may face when lending to the defence industry. Activist groups have increasingly targeted financial institutions, including Barclays, in recent months, protesting the bank’s role in financing companies that manufacture equipment used by military forces such as the Israeli Defence Forces. The issue of reputational risk, along with the broader ethical considerations of weapons manufacturing, has put pressure on lenders and investors as they try to balance their financial interests with the values of their customers.
The U.S. government, under former President Donald Trump, also added a layer of complexity to the situation when it suspended military aid to Ukraine and demanded that European nations shoulder a greater financial burden in protecting their borders. Trump’s call for NATO members to increase their defence spending to 5% of GDP, more than double the alliance’s current 2% target, further underscores the urgency of boosting military capabilities in Europe.
In the context of these growing geopolitical tensions, European leaders like Ursula von der Leyen, President of the European Commission, have framed the current period as one of “rearmament.” This has led to a significant uptick in investor interest in defence companies, as the expectation grows that their order books will expand significantly in the coming years. Data from Morningstar shows that European money managers have increasingly been adding aerospace and defence stocks to funds that adhere to sustainable investment criteria, with the sector’s weight in such funds growing from 0.3% to 0.5% in just two years.
The surge in European defence stocks in recent weeks further reinforces the growing optimism among investors that the defence sector will experience a robust increase in demand. However, as they explore ways to finance the sector, lenders and investors must delicately navigate the complex ethical, regulatory, and reputational considerations at play. In this climate, it’s clear that policy reforms, clearer regulatory signals, and better information-sharing are seen as essential to fostering a financial environment conducive to increased investment in the defence industry.
