Two powerful and often conflicting imperatives dominate the business and policy agenda: sustainability and security. 

Nowhere is the tension between these values more apparent than in the defence sector. On one hand, governments across Europe and beyond are dramatically increasing defence budgets in response to escalating geopolitical threats-most notably Russia’s invasion of Ukraine. On the other hand, financial institutions and investors are becoming increasingly bound by Environmental, Social, and Governance (ESG) criteria that frequently exclude defence-related investments.

The result is a paradox: just as the defence sector is being called upon to scale up production, modernize technologies, and strengthen supply chains, it is simultaneously finding itself excluded from essential sources of capital under ESG frameworks. The rise of sustainable finance -driven by EU regulations such as the Sustainable Finance Disclosure Regulation (SFDR)- has led to the adoption of exclusionary policies that view defence activity as incompatible with responsible investment.

This article explores the ESG challenges facing defence companies and provides a roadmap for how the sector can turn ESG from a barrier into a strategic opportunity.

This article is written by Sefa Geçikli ([email protected]) and Iman Zalinyan ([email protected]). Sefa and Iman are part of RSM Netherlands Business Consulting Services, specifically focusing on Sustainability and Supply Chain Management.  

ESG: A Well-Intentioned Barrier?

Over the past decade, two powerful value systems have converged with growing influence: the imperative to provide national and global security, and the increasing adoption of Environmental, Social, and Governance (ESG) principles. While ESG has brought much-needed accountability and sustainability into business practices, its unintended consequence has been the financial marginalization of industries like defence, which struggle to fit traditional ESG frameworks.

This dilemma has become particularly pronounced in the European Union. As the financial sector embraced ESG-driven policies and regulations, including the Sustainable Finance Disclosure Regulation (SFDR), many banks and institutional investors began applying exclusionary criteria. Defence companies, especially small and medium-sized enterprises (SMEs), have found it increasingly difficult to access capital. According to a paper published by the European Commission in January, this trend is "largely influenced by the implementation of exclusion policies associated with the advancement of environmental and social sustainability in the financial domain."

The issue is compounded by growing geopolitical tensions, especially following Russia's invasion of Ukraine. EU and NATO countries have boosted defence budgets and are pushing to modernize armed forces. Defence companies are thus under pressure to scale up production, diversify exports, and enhance technological capacities. This requires substantial capital investment - just as ESG-based screening makes such capital harder to obtain.

ESG frameworks often treat defence activities as inherently non-sustainable, regardless of their role in democratic societies or their alignment with international law. Many institutional investors apply exclusion policies that disqualify entire sectors -including defence- based on criteria such as involvement with controversial weapons, nuclear arms, or any association with conflict zones.

Not all ESG criteria affect the defence sector in the same way. Some criteria are inherently incompatible with the core operations of defence companies—such as exclusions targeting firms involved in nuclear weapons, uranium production, or controversial arms. These are embedded in many ESG investment frameworks and often preclude such companies from being considered sustainable investments. For firms operating in these domains, achieving ESG alignment may require a fundamental shift in business model or diversification into adjacent, more ESG-compliant markets.

Other ESG criteria relate to business practices that are more amenable to reform. These include reducing carbon emissions, avoiding commercial ties with authoritarian regimes, and strengthening human rights due diligence. Defence companies can make progress in these areas through enhanced governance structures, responsible partner selection, and by adopting more sustainable and transparent operational practices.

Finally, certain ESG criteria are universal and apply to all sectors-such as carbon footprint disclosures, ESG performance metrics, and value-chain due diligence. While these are relatively easier to implement, many defence firms continue to fall short in meeting even baseline ESG reporting standards, further distancing themselves from ESG-conscious investors.

Addressing the Risks 

Despite these barriers, ESG does not have to be a death sentence for defence finance. On the contrary, it may be the very tool that allows responsible defence companies to distinguish themselves and attract sustainable finance. With investor interest in defence rising due to global instability, companies that align themselves with robust ESG frameworks can stand out from the crowd.

  • Tackling Defence-Specific ESG Concerns

One practical path forward lies in enhancing compliance with international norms. Integrating the eight criteria of the EU Common Position on Arms Export Controls into company policy and licensing decisions can significantly boost ESG credentials. These criteria focus on:

  • Respect for international humanitarian and human rights law
  • Risks of diversion and misuse
  • Impact on regional peace and security
  • Consideration of the buyer’s internal situation

By operationalizing these standards through rigorous Internal Compliance Programs (ICPs) and thorough end-user and supply chain screening, companies can reduce the likelihood of their products contributing to repression, conflict, or environmental degradation.

Additionally, aligning export control and sanctions compliance with ESG reporting frameworks allows defence companies to communicate their ethical posture transparently. This builds trust with investors, regulators, and the public, reducing reputational and regulatory risks.

  • Tackling Broader ESG Concerns

Beyond export controls and governance, defence companies must also address broader environmental and social impacts. For example:

  • The defence sector is responsible for up to 5% of global carbon dioxide emissions-a massive contributor to climate change.
  • Metal pollution resulting from the use of weapons has long-term environmental and health consequences.
  • Corruption risks remain high in defence procurement and contracting, especially in fragile or non-democratic states.

To improve overall ESG performance, companies should not only meet minimum expectations but strive to lead. Possible steps include:

  1. Demonstrate and disclose the positive societal impact of defence work-especially in democratic security and peacekeeping roles.
  2. Develop and promote more environmentally friendly defence technologies.
  3. Using renewable energy across manufacturing and logistics operations to reduce carbon footprints.

Forward Looking: Making ESG Work With Defence

The current geopolitical climate has led to a resurgence in interest in the defence sector. Institutional investors and governments alike recognize the strategic importance of secure supply chains and modern military capabilities. For companies that align their governance and sustainability strategies accordingly, ESG can be a competitive advantage.

By addressing investor concerns, improving transparency, and adhering to ethical and legal obligations, defence companies can reposition themselves as sustainable, secure, and responsible. A well-aligned ESG strategy opens the door to sustainable finance, turning a challenge into long-term strategic strength.

RSM is a thought leader in the field of Sustainability and Supply Chain consulting. We offer frequent insights through training and sharing of thought leadership based on a detailed knowledge of industry developments and practical applications in working with our customers. If you want to know more, please contact one of our consultants.