Eroding Barriers to Private Defence Financing in Europe
European governments’ drive to rearm amid new security threats is prompting a re-evaluation of longstanding financial taboos. Across Europe, restrictions that once limited private credit and institutional capital in the defence sector are gradually being dismantled. The European Union is now seeking hundreds of billions of euros in defence investment to bolster its military capabilities – a scale of funding that has made the industry “too important to ignore”. In response, banks, asset managers and regulators are adjusting policies to unlock private financing for defense manufacturers. This marks a significant shift in the continent’s financial landscape, as the defence industry transitions from a cordoned-off sector to one attracting mainstream capital under formal, analytical scrutiny.
Historical Restrictions and Their Impact: For decades, strict environmental, social and governance (ESG) criteria kept many European financiers at arm’s length from the arms industry. Nearly half of European defence SMEs report avoiding bank loans as they are “difficult to obtain”, and over two-thirds have shunned equity funding – a pattern attributed to investors’ ethical concerns and stringent ESG interpretations. Many European banks would only back companies with predominantly civilian revenues, while some excluded defense clients entirely. Even EU sustainable finance rules, which require that investments “do no significant harm,” led many funds to avoid the sector altogether; in recent years, even aerospace firms like Rolls-Royce and Airbus were deemed off-limits in some ESG-labelled portfolios due to their defense divisions. This cautious stance left Europe’s defence firms heavily reliant on state budgets and put the region far behind the United States in private defense capital: between early 2022 and mid-2023, European venture and private equity investment in defense totaled just €32 million, compared to $2.2 billion in the U.S. over the same period.
Shifting Attitudes of Institutional Investors: Today, major European asset managers are reconsidering their policies on investing in defense, under pressure from clients and policymakers to loosen restrictions and help fund the continent’s rearmament. Germany’s Allianz Global Investors became one of the first large firms to roll back its bans, scrapping two exclusions that had barred its sustainable funds from holding defense stocks. As of March 2025, Allianz’s ESG funds can now invest in companies deriving over 10% of revenue from military equipment and even in certain nuclear weapons activities permitted under international treaties. The firm acknowledged its prior limits were too “onerous” and adjusted them to support Europe’s security goals. Similarly, Britain’s biggest investor, Legal & General, has said defence’s appeal has “risen dramatically” and is increasing its exposure to the sector amid geopolitical tensions. Several other top managers – including UBS Asset Management – are reviewing defence exclusions at the board level as clients now actively ask for arms companies to be included in portfolios. Notably, this represents a stark reversal of recent norms: EU and UK regulations do not ban most defence investments (apart from controversial weapons), but until now an ESG-driven ethos had dissuaded many institutions. As one European pension chief put it, “if you rule out defence, you’re the one who has to explain” in the current climate – highlighting how excluding defense is no longer a default stance but a position under scrutiny.
Private Credit Funds Filling the Gap: A parallel shift is underway in Europe’s private credit markets. Many direct lending funds and collateralized loan obligations (CLOs) have historically been constrained by ESG mandates that forbid financing weapons manufacturers. Indeed, Europe’s roughly €250 billion CLO sector has been largely unable to hold loans from defence companies under prevailing criteria. Now, alternative credit providers are seeking ways to loosen these self-imposed limits to tap the growing financing needs of mid-sized defence firms. The few credit funds that have already ventured into the defence space have earned double-digit returns, as illustrated by Czech manufacturer Czechoslovak Group’s recent $775 million bond issuance carrying an interest rate above 11%. Such rich yields reflect both the scarcity of available private financing and the perceived risk premium in the arms business. Sensing opportunity, more private debt funds are exploring changes to their fund documentation and ESG policies so that defence projects become eligible investments. Government officials – notably in France – are adding to this pressure, urging investors to revise fund bylaws and “make defence eligible” in order to align private capital with national security priorities. As these funds gradually adjust their mandates, they stand to fill a critical funding gap, offering new credit lines and bond financing to European defense contractors that historically struggled to access private debt.
Structured Finance Mechanisms Evolving: Innovations in structured finance are further eroding barriers to defence investment. The industry’s advocates are lobbying to ease regulatory constraints so that capital markets can more readily fund defense growth. In early 2025, the Alternative Investment Management Association (AIMA) – representing hedge funds and private debt managers – began working with EU policymakers to relax securitisation rules and capital charges, a move aimed at making it easier to channel private credit into the region’s growing defense industry. By enabling the pooling of defence-related loans into collateralized products (similar to CLOs) with reasonable risk weights, regulators could attract more institutional buyers to these instruments. European market operators are also adjusting their frameworks. Euronext, the pan-European exchange group, announced measures to support defense financing – including a fast-track process to list new defence bonds in as little as two days. It is revisiting its ESG index methodologies to lift exclusions on defense companies, coordinating with rating agencies to restrict the “controversial weapons” label only to arms banned by international treaty. This finer distinction means index funds and ESG-conscious investors would no longer automatically blacklist conventional defense manufacturers. In parallel, more European defence firms are turning to private placements of debt and bespoke funding deals with institutional investors, bypassing public markets. Such tailored financings – often arranged quietly with pension funds, insurers or private banks – are gaining traction as companies seek flexible funding for expansion. Together, these structured finance developments are gradually reducing friction for private investors, providing new avenues (from securitized loan pools to off-market bond issues) to invest in Europe’s defense sector without breaching governance constraints.
French Finance Minister Eric Lombard speaks at the Euronext stock exchange’s annual conference in Paris on March 18, 2025, outlining plans to mobilize private investment for defence. European governments are actively supporting this financial opening through policy and regulatory initiatives. France, for example, is launching a €450 million defence investment fund via its public bank Bpifrance, inviting citizens to contribute in €500 increments to bolster the military industry over the long term. In tandem, French regulators have introduced an accelerated approval process for new defence-focused investment funds, offering asset managers fast-track authorization and guidance when they create vehicles dedicated to the Defence Technological and Industrial Base. The French market authority has also pledged to ensure that EU sustainable finance rules “do not create undue obstacles” to defense financing, signaling a push to adjust ESG frameworks at the European level. Such steps come as officials estimate French defence firms will require over €5 billion in additional equity capital in the next few years – funding needs that far exceed what public budgets alone can supply. At the EU level, similar shifts are underway. In 2024, the European Investment Bank ended its ban on backing defence projects by permitting support for dual-use technologies, and it helped launch a new €175 million Defence Equity Facility (targeted to grow to €500 million) to co-invest in defence startups and SMEs. The EU’s newly appointed Defence and Space Commissioner has explicitly made improving access to finance one of his top priorities. He has floated ideas such as European joint defence bonds and EU-backed guarantees to cover potential loan defaults in the sector, which would de-risk private lending to defence suppliers. These policy moves represent a strategic U-turn: where once the defence industry was largely segregated from private financing in Europe, it is now being actively integrated into the continent’s financial systems. By blending public incentives with private capital, Europe is steadily lowering the barriers for institutional investors and credit providers to participate in funding its defence industrial base – a trend driven by financial pragmatism and the pressing geopolitical imperative to rearm.
Sources:
Reuters – “Europe’s top money managers start to bring defence stocks in from the cold.”
Reuters – “Allianz scraps nuclear, military exclusions to back Europe’s rearmament drive.”
Financial Times – “Private credit firms take aim at ESG for holding back financing for European defence.”
Reuters – “France to launch 450 million euro defence fund amid growing security concerns.”
Reuters – “Euronext rebrands ESG in drive to help European defence firms.”
CEPA – “European Defense: Close the Finance Gap.”