For years, the relationship between defence and environmental, social, and governance (ESG) investing followed a simple logic: weapons meant exclusion. Fund managers, index providers, and ESG rating agencies each drew their own lines, but the direction was broadly the same—defence companies were treated as incompatible with sustainability objectives.
That logic has now been formally challenged by the European Commission. Through a combination of legislative amendments and interpretive guidance published in late 2025, the EU has narrowed the scope of automatic exclusions, reframed defence as a contributor to social sustainability, and clarified that the SFDR, EU Taxonomy, CSRD, and CSDDD do not, in themselves, prevent financing of the defence sector.
The timing is not accidental. Europe’s defence spending has doubled since 2021, rising from €218 billion to an estimated €381 billion in 2025. NATO allies have agreed to a new 3.5% of GDP benchmark by 2035 for core defence spending. And with approximately €6.4 trillion in assets sitting in Article 8 and Article 9 SFDR-classified funds, unlocking even a fraction of this capital for the defence sector represents a significant policy objective.
What Changed: The Regulatory Timeline
The regulatory shift unfolded across 2025 and into 2026 through a sequence of policy signals, legislative proposals, and formal acts. Click on each event to expand.
The European Commission published the ReArm Europe Plan, envisaging up to €800 billion in defence investments over four years. The White Paper stated explicitly that the SFDR does not prevent financing of the defence sector.
European Commission Press Release →The UK Financial Conduct Authority confirmed that nothing in its rules, including sustainability-related rules, prevents investment or finance for defence companies.
FCA Statement →The European Commission adopted the Defence Readiness Omnibus, a package of legislative and non-legislative measures including the Commission Notice on the sustainable finance framework’s application to defence, and the Delegated Regulation amending weapon definitions under climate benchmarks.
EC Defence Readiness Omnibus →NATO allies agreed to a new benchmark of at least 3.5% of GDP for core defence spending by 2035, replacing the previous 2% guideline. The broader 5% target includes resilience and innovation spending.
NATO Hague Summit Declaration →The Commission adopted Delegated Regulation (EU) 2025/1775, amending Delegated Regulation (EU) 2020/1818 on sustainable finance benchmarks. The key change: replacing “controversial weapons” with “prohibited weapons,” narrowing automatic benchmark exclusions to four categories prohibited under international conventions.
EUR-Lex: Regulation 2025/1775 →The Commission Notice on the sustainable finance framework and CSDDD applied to defence was published in the Official Journal. It confirms that the EU sustainable finance framework is compatible with defence investment, sets no sector-specific financing limitations, and clarifies that PAI indicator 14 covers only four categories of weapons.
EUR-Lex: Notice C/2025/4950 →Delegated Regulation (EU) 2025/1775 takes effect, with a transitional period for existing benchmarks. From this date, only companies involved in prohibited weapons must be excluded from PAB and CTB-labelled indices.
EUR-Lex: Regulation 2025/1775 →The Core Change: From “Controversial” to “Prohibited”
The most consequential change is definitional. Under the previous framework (Delegated Regulation (EU) 2020/1818), the term “controversial weapons” served as the exclusion trigger for EU Climate Transition Benchmarks (CTBs) and Paris-Aligned Benchmarks (PABs). This term was legally vague and interpreted differently across ESG data providers, fund managers, and index administrators.
The Commission acknowledged that this term “creates uncertainty and confusion, because the relevant international treaties and conventions to which Member States are parties reference prohibited weapons rather than controversial weapons.”
The European Parliament tabled motions objecting to Delegated Regulation 2025/1775, arguing that the narrower definition contradicts the principle of environmental sustainability and that weapons such as nuclear weapons, depleted uranium, and lethal autonomous systems should remain excluded. The Parliament did not secure a majority to veto the regulation, which was published in the Official Journal on 30 December 2025.
The Spending Context
EU Member States collectively spent €343 billion on defence in 2024, a 19% year-on-year increase, and an estimated €381 billion in 2025—pushing above 2% of GDP for the first time. Defence expenditure across the bloc has nearly doubled since 2021.
This spending surge creates a financing need that exceeds what government balance sheets can sustain. The European Commission’s Readiness 2030 initiative envisages creating fiscal space for up to €800 billion over four years. Unlocking private capital—including from ESG-labelled funds managing trillions in assets—is explicitly part of the strategy.
How Each Framework Applies to Defence
Commission Notice C/2025/4950 provides guidance across the full sustainable finance framework. Select each regulation below for key clarifications.
Sustainable Finance Disclosure Regulation (SFDR)
The Commission confirms that the SFDR does not prevent financing of the defence sector. The framework sets no limitations on any specific sector.
PAI Indicator 14 (“share of investments in investee companies involved in controversial weapons”) covers only four categories: anti-personnel mines, cluster munitions, chemical weapons, and biological weapons. Nuclear weapons are explicitly not covered.
Article 8 and 9 classification does not in itself prohibit defence exposure. A defence investment can qualify as a “sustainable investment” under SFDR if it: (a) contributes to an environmental or social objective; (b) passes the Do No Significant Harm (DNSH) test across all PAI indicators; and (c) follows good governance practices.
Revenue thresholds: The EU framework does not prescribe exclusions based on a percentage of a company’s turnover in defence activities, or on a percentage of a fund’s portfolio invested in defence.
Reference: Commission Notice C/2025/4950, OJ 30 December 2025
EU Taxonomy Regulation
The EU Taxonomy does not include defence activities among its six environmental objectives. However, the Commission clarifies that this exclusion does not prejudge the environmental performance of defence companies, nor should it impede their access to finance.
Defence companies with eligible economic activities (manufacturing, transport, energy) can report Taxonomy-alignment for those activities. The absence of a “social Taxonomy” means there is no framework-level intention to single out the defence sector.
Reference: Regulation (EU) 2020/852; Commission Notice C/2025/4950
Benchmark Regulation (BMR)
This is where the most concrete change occurred. Delegated Regulation (EU) 2025/1775 amends the 2020/1818 standards for EU Climate Transition Benchmarks and Paris-Aligned Benchmarks.
The term “controversial weapons” is replaced with “prohibited weapons,” defined as: anti-personnel mines, cluster munitions, biological and chemical weapons whose use, possession, development, transfer, manufacture, and stockpiling is expressly prohibited under international arms conventions to which the majority of Member States are parties.
The regulation applies from 30 June 2026, with a transitional period for existing benchmarks authorised before that date.
Direttiva sulla rendicontazione aziendale in materia di sostenibilità (CSRD)
The CSRD and European Sustainability Reporting Standards (ESRS) apply to defence companies within scope on the same basis as any other sector. No sector-specific reporting exemptions were introduced.
Defence companies subject to ESRS will report across all material topics, including climate, workers, affected communities, and business conduct. The February 2025 Omnibus (Directive (EU) 2025/794) deferred application timelines but did not change the reporting requirements.
Corporate Sustainability Due Diligence Directive (CSDDD)
The CSDDD applies to defence companies in principle, with the first application date deferred to July 2027. The Commission Notice recalls that downstream activities connected to authorised exports are within existing regulatory export control frameworks.
Defence companies will conduct value chain due diligence, but the practical scope is tempered by established export control regimes (Wassenaar Arrangement, EU Common Position on Arms Exports, national licensing frameworks).
Key Legislative References
| Instrument | Date | Stato | Source |
|---|---|---|---|
| Delegated Regulation (EU) 2025/1775 Definition of prohibited weapons |
28 Aug 2025 OJ 30 Dec 2025 |
Applies 30 Jun 2026 | OJ L 2025/1775 |
| Commission Notice C/2025/4950 SF framework & CSDDD applied to defence |
30 Dec 2025 | In force | OJ C/2025/4950 |
| Regolamento (UE) 2019/2088 (SFDR) | 27 Nov 2019 | In force | OJ L 317 |
| Regulation (EU) 2020/852 (Taxonomy) | 18 Jun 2020 | In force | OJ L 198 |
| Delegated Reg. (EU) 2020/1818 CTB & PAB standards (original) |
17 Jul 2020 | In force (amended) | OJ L 406 |
| Directive (EU) 2024/1760 (CSDDD) | 13 Jun 2024 | Application Jul 2027 | OJ L 2024/1760 |
| Directive (EU) 2025/794 Omnibus — CSRD/CSDDD deferral |
14 Apr 2025 | In force | OJ L 2025/794 |
What This Means for Investors and Reporting
For fund managers
Article 8 funds can hold defence exposure without triggering an SFDR classification issue, provided the fund’s own investment policies and exclusion criteria permit it. Several major asset managers—including Allianz Global Investors, UBS, and Danske Bank—have already adjusted their exclusion policies. Around 43% of ESG European equity funds now hold some aerospace and defence exposure, up from significantly lower levels in 2022.
Article 9 funds face a higher bar. Classifying a defence investment as a “sustainable investment” requires demonstrating contribution to an environmental or social objective, passing the DNSH test, and confirming good governance. Approximately 80% of Article 9 European equity funds still have zero A&D exposure.
For defence companies
The removal of automatic ESG exclusions does not remove the need for ESG reporting and performance. Defence companies within scope of the CSRD will report under ESRS. Those within scope of the CSDDD will conduct value chain due diligence. ESG rating agencies will continue to assess defence companies, and many will retain higher-risk ratings based on the sector’s inherent environmental and social characteristics.
For ESG data and technology providers
The shift increases demand for granular, framework-compliant data. Fund managers need to demonstrate, on a case-by-case basis, whether a defence holding passes the SFDR sustainable investment test. This requires reliable data on PAI indicators, weapons involvement classifications, governance practices, and supply chain due diligence. The fragmentation of national export control regimes adds further complexity to cross-border data requirements.
Companies such as Airbus, Safran, and Thales produce technologies with both civilian and military applications. Since investors typically invest in the company as a whole rather than in isolated business units, separating defence exposure from civilian activity is often impossible. This creates a data classification challenge that standardised ESG frameworks have yet to fully resolve.
Outlook
The regulatory direction is settled in its broad strokes, but several questions remain open. The SFDR review—expected to introduce new fund categorisation rules—may create additional clarity on how defence exposure is treated within sustainability-labelled products. ESMA’s fund naming guidelines have already separated benchmark exclusions from fund naming, but the interaction between the two will continue to evolve.
The broader question is whether defence can be meaningfully integrated into ESG frameworks, or whether it will remain a parallel investment category—accessible to sustainable funds but never fully “sustainable” in the way renewable energy or social housing might be. The Commission’s reframing of defence as a contributor to social sustainability through “resilience, security, and peace” is a political and legal argument, not yet a market consensus.
For ESG data platforms, reporting tools, and compliance technology, the intersection of defence and sustainability represents a growth area. The data requirements are complex, the regulatory landscape is multi-layered, and the demand for transparency is increasing from both regulators and investors.
