In an era of increasing geopolitical competition and global conflict, national security has risen up His Majesty’s (HM) Government’s list of priorities. However, as General Sir Roly Walker, Chief of the General Staff, recently warned, securing investment in defence is negatively impacted by Environmental, Social and Governance (ESG) criteria. Despite this issue being highlighted, there is ongoing reluctance to reimagine ESG for a new era. So, in this week’s Big Ask, we asked five experts: How should ESG be reformed to empower national security?
Senior Director of Policy, China Strategic Risks Institute
For years there has been a wealth of evidence of public pension funds, ESG funds, and index trackers actively and passively investing in Chinese companies with alleged links to the People’s Liberation Army (PLA) and are connected to human rights violations taking place against the Uyghur ethnic group in Xinjiang.
These investments have not and do not meet the ESG criteria which these investors claim to adhere to. Yet, there remains no recourse to force divestment beyond public pressure, as the ESG market remains self-regulated despite promises by the last government to legislate ESG standards.
It is beyond the realms of absurdity that our pension funds are investing in the development of technology and weapons that will be used by the People’s Republic of China (PRC) as part of its civil-military fusion abroad, but we cannot invest in rearming and defending national security at home.
We clearly need a properly regulated ESG sector that offers a sensible carve out for domestic defence production and a requirement for pension funds to review their investments in Chinese companies with links to the PLA.
Associate Fellow, Council on Geostrategy
We cannot force investors to put their money into stuff they don’t believe in. But ESG investment strategies come in many varieties and, to the cynical, their adoption by fund managers and their marketing increasingly looks like a cover story for simple risk aversion.
I would like to see defence-oriented funds created in the private sector and backed by large public sector pension schemes. Issuing, for example, a Defence Premium Bond – no matter how small the issuance – would be a big signal.
Anecdotally, though ESG strategies can cause problems for the defence sector, there is just as much pushback coming from hostile or neutral countries in the financial system.
Only government can sort this out: by taking demonstrative and positive actions to back defence investment, by using soft power in the relevant boardrooms and through de-risking. The political battle to present defence investment as the most socially responsible thing one could do in a time of crisis has to be led by government.
The industry itself, of course, needs to work harder on the E and the G bits of the problem, especially corporate governance.
Policy Officer, Progressive Britain
As Rachel Reeves, Chancellor of the Exchequer, reiterated in her landmark speech on 29th January, growth is the top priority of this Labour government. To fuel growth, Reeves has committed to releasing Britain from the self-imposed shackles of excessive red tape.
In an increasingly uncertain geopolitical context, defence is rightly recognised as a key area for investment to not only deliver growth but more fundamentally, to guarantee the first duty of government – the defence of the realm. Despite defence being identified as one of eight high growth sectors in the forthcoming Industrial Strategy, government backed crowding-in is hampered by ESG concerns from investors, excluding defence from much needed private sector financing.
As with other barriers to growth and investment, the application of ESG rules to defence are liable to misappropriation to block investment. For instance, there is nothing mutually exclusive about the UK’s environmental obligations and investment – the country just needs creative solutions such as the new Nature Restoration Fund.
Furthermore, while there is an obligation to ensure that the defence industry abides by ethical responsibilities, there is nothing progressive about inhibiting Britain’s ability to develop cutting-edge technologies to defend the UK and the free and open world through military aid to Ukraine.
Chief Economist, ADS Group
A strong national defence and security industrial base is a pre-requisite for the freedoms which we often take for granted and is integral to addressing ESG ambitions, including safeguarding and peacekeeping. The defence industry is fully aligned with the aims of avoiding conflict and promoting economic growth.
From an investment perspective, it’s time to reframe how ESG is thought about when it comes to the defence industry to avoid exclusionary policies and negative ratings that put national security at risk. Leading ESG ratings do not always have transparent methodologies, and we have started to see investors and finance providers developing ESG policies and statements which exclude activity relating to defence. This is where the defence industry would like to see reform, to ensure that investment funds are appropriately supporting investment in the sector, which is so critical to national security.
Additionally, the defence and security industry in the UK are large employers with significant footprints in local and regional economies. Likewise, the industry-led UK Defence ESG Charter is driving voluntary action on a range of sustainability issues among companies including the clean energy climate transition, resilience in the critical minerals supply chain, Diversity, Equity, and Inclusion, nurturing the development of science, technology, engineering, and mathematics (STEM) skills, and improving corporate governance for cybersecurity and export controls.
Senior Research Fellow in Science, Technology, and Economics, Council on Geostrategy
Ethical investing is thought to have started with faith groups, such as the Quakers and Methodists, who wanted to make a moral choice about where and how they invested. They wanted to ensure they did not provide financial support to things they found to be morally reprehensible, such as the slave trade.
In 1971, two Methodist ministers started the first socially responsible mutual fund in the United States (US), Pax World, so that the churches’ investments would not financially support the Vietnam War.
Before Russia’s war of aggression against Ukraine, there has been an increase in investment based on ESG considerations. That meant that defence firms were shut out from large pools of capital. Since Russia’s invasion, however, there has been a re-evaluation about whether stocks from the aerospace and defence sector should be included in ESG-labelled funds.
There is an inconsistency in the way some ESG funds are run. ESG funds have, for example, been found to support companies linked to forced labour in Xinjiang. Such funds seem to either be unable or unwilling to conduct thorough due diligence on Chinese supply chains.
At the same time, as two ministers in the previous government argued: ‘peace needs defence, and defence needs an industrial base’. That is, there is a contradiction in shutting out defence sector companies from investment while trying to support Ukraine’s right to defend itself.
So ESG needs to be reformed to remove this contradiction, and so that it reflects our values. To put it another way, we need to ensure we do not provide economic support and leverage to unfriendly nations who use forced labour to monopolise important supply chains, and at the same time, we need to ensure we are better able to support allies to defend themselves in an increasingly contested and volatile world.
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