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Rise of ESG adds to pressure on European defence companies Financial TimesRise of ESG adds to pressure on European defence companies Financial TimesRise of ESG adds to pressure on European defence companies Financial Times

Impact Investing Forum 2024

London. April 24-25, 2023.

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Antiwar demonstrators are used to targeting defense executives, who often try to disrupt shareholder meetings and trade fairs. Socially conscious investors are now threatening the industry. They are demanding that companies reduce the carbon footprints for fuel-hungry fighter planes and battle tank. They are also urging greater transparency in the sale and manufacture of weapons, following a recent increase in environmental, social, and governance investing. The federation points to the contradictions between the EU’s desire for stronger defense capabilities and draft proposals on criteria to determine which sectors are socially beneficial or harmful. Alessandro Profumo is president of ASD, and chief executive of Leonardo, an Italian defense group. He stated that it was important that EU initiatives on sustainable finance don’t contradict other EU policies. EU measures should recognize the importance of the sector. . . The defense of the homeland is an essential part of sustainability. It must be recognized as such. Without security, there is no sustainability.”

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Other European executives have warned that there is a valuation gap with the US. In this country, defense groups are more accepted for their role in government contractors, despite not being eligible for ESG-focused funds. However, some executives are fighting back. Many of Europe’s largest defense companies, including Thales in France and BAE Systems in Britain, have increased their efforts to explain their work and highlight their contributions to national security and economies. Last month, both Thales and BAE held ESG-focused seminars. Sir Roger Carr, chairman of BAE, the UK’s largest defense contractor, said that if any sector is blackballed, it restricts where money can be put to work and ultimately loses out on good returns. He was responding to an analyst’s query at the company’s last month event. “We are there to help ourselves, but also to assist the industry to ensure that this sector is not on the naughty side and is understood for its value and the ethics and principles it applies in the delivery of its product. “Bertrand Delcaire is head of investor relations at Thales. He said that cyber security, in which Thales is a tier-one company, can be seen to be a positive ESG activity, while other elements of Thales’ product portfolio, such as radars, sonars, and military communication systems, that contribute to physical security, are seen as a negative ESG. European executives are concerned about the lack of clearly defined ESG investment criteria. They fear this is holding back the sector. Charles Woodburn, chief executive at BAE, stated that the industry is “suffering from a shortage of consensus in defining ESG Compliance, which is causing some funds to exclude all defense stocks, rather than taking an more considered approach to assessing individual company strategies and portfolios.” “European defense stocks are trading at lower multiples than their US counterparts due to investors adopting stricter ESG criteria,” he said. “Blanket ESG exclusions leave no room for compromise. It is not sensible to exclude all companies with more than 5-10% of sales in defense from an ESG fund without carefully considering the products they make,” said one European executive. “ESG continues to be a major headwind for European defense companies, even though it has yet cross the Atlantic.” Many European investors have ‘blacklisted the sector as a whole. Even if defense companies replanted Amazon, they would still be on that blacklist.

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KLP, a Norwegian pension group, is tightening its approach in Europe. KLP, a Norwegian pension group, is tightening its approach to Europe. It recently announced that it had sold $147m worth of holdings in companies such as Raytheon USA and Rolls-Royce UK. This was due to their links to nuclear weapons. Aziz said that investors are not new to concerns about defence groups. Investors are not allowed to invest in controversial weapons like cluster bombs or landmines, as per international treaties. This is well-established in asset management. Many mainstream funds adhere to universal indexes such as MSCI. These can vary from universal indices that have the “smallest exclusions like landmines or cluster munitions” to those that use higher ESG rates. Meggin Thwing Eastman is research editor for MSCI ESG Research. ESG investors often exclude weapons manufacturers from funds because they are often lumped in with tobacco and coal businesses. BlackRock’s ESG exchange traded funds are screened and exclude weapons manufacturers. Vanguard’s ESG global corporate bonds ETF excludes debt from weapon makers. “ESG funds are increasingly dominating asset flows, so negative screening has increased. . . The EU defense market is now trading at a level with tobacco after a 30% premium in late 2019. Keyworth said that the reason for the decline in EU defense trades was “partially due to the rise in ESG investor concerns in Europe”. The UK’s defence stocks are trading at a premium relative to the wider UK market, thanks to a series of takeover activity.

Another area of concern is nuclear. Executives are being asked more frequently about their work on nuclear defense programs in other countries. Babcock International, Britain’s second-largest contractor, published an investor FAQ about nuclear weapons in its annual report for the first year. Thales used its ESG event to explain that it was one of more than 140 suppliers to the French nuclear missile program, but that it was not a specific supplier to the nuclear weapons programme. BAE also used the event to promise to end its dependence on white phosphorous (a controversial chemical component in incendiary arms). It stated that less than 0.1% of its sales still relate products containing whitephosphorous and that it was currently in discussions with the UK Ministry of Defence to find a replacement. It is likely that it will be harder to make the case for defense. Vertical Research’s Stallard warned that the continued ESG headwinds could not only undermine the defensive properties of defense stocks, but also potentially risk them becoming an uninvestable asset type for European fund managers.” Additional reporting by Patrick Temple West in New York

Video: Gillian Tett explains ESG’s importance

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ESG Investing Conference