SFDR and PAI 14: The Edge of Compatibility
The EU Sustainable Finance Disclosure Regulation (SFDR) distinguishes between “Article 8” funds (those promoting environmental or social characteristics) and “Article 9” funds (those having explicit sustainable-investment objectives). Neither category explicitly bans investments in defence industry companies, but both must account for principal adverse impact (PAI) indicators and “do no significant harm” (DNSH) criteria. Crucially, PAI Indicator 14 (Annex I of the Level 2 RTS) targets “exposure to controversial weapons (anti‑personnel mines, cluster munitions, chemical and biological weapons)”. In practice, any company involved in developing or selling banned or severely restricted weapons must be excluded from SFDR-labelled funds, and funds must report the fraction of their investments in such companies. By contrast, conventional military equipment (tanks, fighter jets, etc.) is not covered by PAI 14, and Article 8 funds may hold these companies if they meet the fund’s ESG criteria and exclusion lists. Article 9 (“dark-green”) funds, however, set a higher bar: defence companies generally do not contribute to their stated sustainable objectives and are thus normally excluded or at least not counted as “sustainable investments”.