“Neither Indosuez nor Credit Agricole ever had a policy to exclude the defence sector,” said Alexandre Drabowicz, CIO at Indosuez Wealth Management, during an interview. Instead of introducing a sector-wide ban, as some of its competitors have done, Indosuez’s exclusion policy has been more specific, targeting particular companies or issuers involved in the production of “non-conventional” or “controversial” weapons. This indicates a more pragmatic stance rather than rejecting outright the entire defence industry.

“S” for “security”

Drabowicz pointed to an evolving understanding of ESG (environmental, social, governance), particularly the “S” component. There’s a growing sense among financial actors, he said, that the “S” needs to broaden its scope from purely “social” aspects to include “security.”

“There can’t be social peace without a secure environment at national borders,” stated Drabowicz. This realisation is driving the understanding that governments will require financial backing for defence spending, and that European regulations will need to accommodate these plans.

From an investment standpoint, when considering defence companies, Indosuez’s approach could be described as best-in-class. Across all sectors, including defence, the strategy involves selecting companies with strong ESG profiles and excluding those that are less virtuous or more controversial. This is not a dogmatic approach to exclude the entire defence sector but rather a selective one based on ESG criteria.

The defence ecosystem

In France, for instance, the finance ministry--through public development bank BPI--is launching programs to finance companies, especially small and medium-sized enterprises (SMEs), within the defence sector via private equity. It’s noteworthy that there are approximately 4,500 SMEs in France that are part of the defence ecosystem, and these are the entities particularly in need of funding.

Unlike larger corporations like Airbus, Dassault and Safran, which can access financial markets, these SMEs have order books that are filling up and require capital to invest and hire. Therefore, the current challenge within the ESG framework is to facilitate the financing of these defence-related SMEs. This has led to initiatives in France, and Drabowicz anticipates similar developments in other countries.

Drabowicz concluded that the financial world must align with the new emphasis on security, which will necessitate a more flexible understanding of ESG that acknowledges the interconnectedness of security and social wellbeing. This implies that considering defence within an ESG framework is not contradictory but requires a more nuanced and adaptable perspective.