The Defense Industry: an Unintended Victim of Financial Regulation 

If the Russian invasion of Ukraine has taught us one thing, it’s that Europe’s security environment has changed profoundly. In a time when the EU’s ability to achieve strategic autonomy is anything but certain, this three-part series, Financing Defense in the 21^st Century, examines the importance of the defense industry for Europe and considers ways to guarantee its resilience. In this second article, Nicolas Bavarez considers the link between financial regulation and investment in the defense sector.

Building on the momentum of the Paris Agreement, the EU initiated a sustainable finance agenda in 2016. The Union set ambitious goals: it seeks to make sustainable finance the norm in Europe, and strives for Europe to become the global leader in this domain. In line with an action plan - for which an update is expected soon - it has launched a series of legislative initiatives. These intend to achieve three main objectives:

• The first aim is to redirect capital flows. To this end, the Commission worked with a group of technical experts to develop a taxonomy of sustainable activities, which was adopted in June 2020. In July 2021, the Commission proposed an EU Green Bond Standard. It is currently working on the regulation of "climate transition" or ESG benchmarks - adopted in December 2019 - as well as labels for investment products that claim to be environmentally responsible. In addition, the Union has ensured that its own investment plans, in particular Invest EU and the Green Deal, are consistent with these standards.
   
• The second aim is to make sustainability a widespread practice in risk management. This means ensuring that ESG criteria are taken into account by credit rating agencies (the European Securities and Market Authority published guidelines in July 2019). The Commission has also proposed to reinforce reporting on sustainability issues by asset managers and institutional investors. The Corporate Sustainability Reporting Directive (CSRD), adopted in March 2021, requires each investor to report on its ESG policies and their implementation. Finally, the Commission is considering changes to the prudential frameworks of banks and insurance companies by integrating objectives related to the ecological transition.
   
• The third aim is to reinforce and overhaul the Non-Financial Reporting Directive (NRD). Two new structures are set to be created: a European standard-setting body and an International Sustainability Standards Board. The latter would operate under the auspices of the International Financial Reporting Standards Foundation. Regulatory initiatives on due diligence and the responsibility of boards of directors are also under discussion.

Sustainable development issues are often treated in isolation, with measures adopted in response to social demands following major events, such as the Rana Plaza disaster in Bangladesh in 2013. In this regard, the European Commission and Parliament may be commended for aiming to create a coherent, overarching framework to address sustainable development issues. Nevertheless, many of the EU’s intentions remain vague, illustrated by the particular case of defense industry financing.