The Shifting ESG Landscape in the Defense Industry: New Perspectives on Sustainability

The defense industry has historically faced significant challenges in being considered sustainable by investors due to ESG (environmental, social, and governance) perspective. Before the war in Ukraine, the sector experienced declining interest from institutional investors due to ESG concerns. This trend was heavily influenced by public perception, despite the sector's profitability. 

While the defense industry is increasingly engaging with ESG frameworks, it’s important to acknowledge a fundamental tension: many defense products remain at odds with the core principles of sustainable development. International frameworks such as the United Nations Sustainable Development Goals (SDGs) explicitly promote peaceful and inclusive societies. In particular, SDG 16 calls for the advancement of peace, justice, and strong institutions. The nature of defense sector activities and products can directly conflict with these aims, raising challenging questions about how, or even whether such companies can fully align with global sustainability objectives.  

A major obstacle has been the nature of the industry itself. Defense companies often face exclusion from ESG investment portfolios due to what are classified as "hard-to-abate criteria". These are factors that defense companies cannot address due to the inherent nature of their core business. These include involvement in controversial weapons, nuclear weapons, and related technologies. 

The geopolitical landscape has shifted dramatically since February 2022, when Russia's invasion of Ukraine began. Since then, public perception has evolved significantly, with a growing recognition of the importance of national security and how defense capabilities protect democratic values and human rights. This has also meant a turning point in how the defense industry is perceived through an ESG lens – by the investors and the public alike.   

Evaluating emerging defense technologies is no longer as straightforward as it once was. The convergence of the defense and technology sectors is giving rise to a new hybrid domain: DefenceTech. This evolving landscape—where artificial intelligence, cybersecurity, quantum computing, and autonomous systems redefine what constitutes a weapon—poses complex challenges for responsible investors.  

Technologies originally designed for civilian use are increasingly being repurposed for military applications. This dual-use dynamic complicates ESG assessments, as the same innovation may serve both peaceful and defense-related ends. As a result, defense companies begin to resemble tech firms, while tech firms become integral to national security infrastructure and decision-making.  

This transformation raises critical questions for ESG-minded investors. Traditional sustainability frameworks often struggle to accommodate the nuances of defense-related innovation. For example, how should one assess the ESG profile of a cybersecurity firm that supplies both commercial clients and military institutions? Or a quantum computing company whose algorithms are used in strategic defense simulations?  

To responsibly include defense-related companies in sustainable portfolios, investors must conduct rigorous due diligence. This includes evaluating compliance with international legal norms, understanding the nature and use of products, and scrutinizing customer bases. The goal is not to exclude defense categorically, but to distinguish between companies that uphold ethical standards and those that do not.  

This shift has translated into renewed investor interest, and financial institutions are reconsidering their approach. Banks and institutional investors are expanding investment opportunities in the defense sector and removing previously excluded companies from their exclusion lists. However, investors are generally maintaining restrictions on controversial weapons prohibited by international agreements (cluster bombs, anti-personnel mines, biological and chemical weapons, and nuclear weapons not complying with the Non-Proliferation Treaty).   

For institutional investors, the classification of ESG criteria provides a framework for evaluating defense companies:   

• Hard-to-abate criteria (e.g. controversial weapons and business with non-democratic countries)   

• Medium-to-abate criteria (e.g. carbon emissions and other environmental impacts) and   

• Easy-to-abate criteria (like carbon disclosure and general ESG issues throughout the value chain) offer potential pathways for defense companies to improve their ESG standing.  

There are different approaches in how institutional investors have been excluding defense companies from their investment portfolios:  

• Revenue-based exclusion: Companies are excluded if their revenue from defense products exceeds a specified threshold. This method is straightforward, but reliable data availability can be a challenge. Notably, revenue-based exclusion is especially applicable to companies manufacturing dual-use products— those that serve both civilian and military purposes — since it allows investors to set clear boundaries based on the proportion of defense-related business.  

• Product-based exclusion: The focus is on what the company manufactures, excluding those involved in controversial weapons, for example. The main challenge lies in definitions — such as whether nuclear weapons are considered controversial, e.g., the EU has changed its approach and no longer sees nuclear as controversial. An additional complexity arises in how to approach anti-personnel mines, especially in the context of Finland's, Poland's, Estonia's and Lithuania's potential withdrawal from the Ottawa Treaty, which bans these weapons. Changes in national policy can directly impact how investors and institutions define and apply product-based exclusions. 

• Conduct-based exclusion: This approach considers how the company operates, such as whether it complies with international agreements or sells weapons to countries involved in human rights violations. In this case, the nature of the customer matters more than whether the weapon is conventional or controversial. Again, reliable data availability can be a challenge.  

Instead of relying solely on exclusions listed above, investors should also utilize other responsible investment methods, such as “positive screening” (best in class), where the most responsible actors in the sector are identified and selected as investment targets. Furthermore, investors should be encouraged to practice active ownership: seeking to influence the responsible conduct of their portfolio companies through engagement, voting, and other stewardship activities.  

Also, defense companies are now looking to improve their ESG standing by implementing various ESG measures. Both industry specific and general ESG topics should be carefully considered.   

The changing landscape is prompting companies to reconsider their business practices by:   

• Adjusting product portfolios after thorough ESG evaluation  

• Focusing on defensive technologies and non-lethal alternatives  

• Developing more advanced products with higher precision to reduce civilian casualties  

• Moving away from products using conflict materials  

• Assessing ESG impacts across value chain  

• KYC scrutiny – knowing and controlling the end-customers and the use of the products   

In addition to the above, companies should integrate general ESG consideration into their strategy and day-to-day business operations:   

• Creating assessment frameworks to evaluate ethical and ESG risks in business decisions  

• Formulating company and supplier codes of conduct to avoid unethical practices and ESG violations  

• Implementing renewable energy usage across value and supply chains  

• Increasing transparency in decision-making and public communication  

• Improving communications about positive ESG impact  

As national security becomes increasingly intertwined with technological innovation, ESG frameworks must evolve. Responsible investment in defense is not about endorsing conflict — it’s about supporting transparency, governance, and ethical resilience in a sector that is vital to protecting democratic values, peace and stability.  For defense companies, the path forward involves implementing comprehensive ESG strategies that address industry-specific challenges while also meeting broader sustainability expectations. For investors, the challenge lies in balancing security considerations with responsible investment principles.  

As public perception continues to shift and ESG frameworks adapt, defense companies have an opportunity to position themselves not just as providers of security but as contributors to sustainable progress in a complex world.