ESG and Defence Spending

By Paul Kelly

In the context of the Russian invasion of Ukraine, EU countries are increasing their defence spending, adding to the order books of Western defence firms. This extra spending in EU countries will almost certainly not lead to human rights abuses, and is in fact meant to guard and deter against the sorts of human rights abuses seen in Ukraine. Hence, this has altered the moral calculus of buying shares in firms exposed to the production of small arms and other weapons systems. Therefore, it is likely that there will be pressure on ESG funds to revise or refine their guidance with regard to defence firms.

Already, Citigroup and SEB of Sweden have reversed ESG policies on arms manufacturers, with Citigroup explicitly citing the defence of liberal democracy and creating peace and stability as reasons. This, however, seems currently to be a minority position. As of the 2nd April this year, stakeholders for the S&P 500 and the Dow Jones Index made additions to exclusions list for the S&P ESG indices. These exclusions included revenue thresholds of 5% for small arms manufacture or distribution, 10% for military contracting and outright exclusion for companies with any revenue from providing components for controversial weapons2. Therefore, it is possible that some ESG stakeholders will try to avoid ethical ambiguity to do with killing by avoiding the issue altogether.

However, a few key trends may conspire to make ESG funds drop arms manufacturers from exclusion lists. Firstly, as defence spending rises following recent Russian aggression, and also rises in countries threatened by similarly large and authoritarian neighbours, the share price of defence stocks will rise. This, in addition to ethical concerns from investors, may create pressure to drop arms manufacturers from exclusions list. This may be especially true if they have less exposure to countries with a history of human rights abuses.

Furthermore, it may also be possible to make more fine-grained criteria for ESG funds to include defence stocks that are deemed to have a positive or neutral ethical impact. Before the Russian invasion, it was implicitly assumed that larger, more advanced economies would not go to war, so capitalising arms manufacturers was not an ethical priority. This made it easy for ESG funds to lay the subjective issue of the politics of defence aside and lay a blanket exclusion of defence firms from ESG lists.

Given the immediacy and necessity of action of recent events, however, it may make sense to create a more fine-grained criteria for exclusion, where only arms firms supplying to countries that may commit human rights abuses or break international law are restricted. These hypothetical new criteria will not capture many larger arms firms like BAE Systems, which sells arms to various countries that commit human rights abuses, whose sometimes Western-supplied aircraft are thought to be responsible for thousands of civilian deaths in Yemen. However, though many larger firms would still be excluded from ESG funds, it would still allow some defence firms to receive ESG funding and would create a larger incentive for defence firms to scale back involvement with countries committing human rights abuses.

References:

  1. https://www.reutersevents.com/sustainability/esg-watch-war-ukraine-sheds-harsh-new-light-sustainable-finance
  2. https://www.indexologyblog.com/2022/04/27/what-is-new-in-sp-esg-indices/?utm_source=feedotter&utm_medium=email&utm_campaign=FO-04-27-2022&utm_content=httpswwwindexologyblogcom20220427whatisnewinspesgindices&mkt_tok=ODM4LUxEUC00ODMAAAGEDANPrpw-7bs_jKRsw3IBt3M64w52RS1-4Trb2k5h_nxOUZnjKY7Q7Ol3SUAd61U9zwK_Hwnn_MPtdEKSyY2HWhB_ZkPVglW3LX0dGDB2uw
  3. https://www.amnesty.org/en/location/middle-east-and-north-africa/egypt/report-egypt/
  4. https://www.theguardian.com/business/2020/apr/14/bae-systems-sold-15bn-arms-to-saudis-during-yemen-assault
  5. https://www.bbc.co.uk/news/world-middle-east-29319423