The International Capital Market Association’s top sustainable finance body has ruled out allowing bonds for defence investments to be issued with green, social or sustainable labels but may consider separate guidance or even a dedicated label as military spending increases amid geopolitical instability.
An update of the executive committee of the Green, Social, Sustainability and Sustainability-Linked Bond Principles' voluntary guidance handbook "confirmed the likely ineligibility" of defence projects being funded by labelled bond proceeds.
"We do not see that defence projects generally are compatible with the investments in GSS bonds. So we think that most investors will likely not buy bonds where the eligible use of proceeds extends to defence projects," said Isabelle Laurent, deputy treasurer at the European Bank for Reconstruction and Development and chair of the committee.
The body's vice chair is Alban de Fay, head of fixed income SRI processes and senior portfolio manager at Amundi. It represents another seven heavyweight asset managers including BlackRock, Mirova, Pimco and Zurich and undertook "quite significant" research with investors, Laurent said.
Away from its sustainable finance work, ICMA is open to the idea of labelled defence bonds that would "mimic" ESG bonds' use-of-proceeds structures, said Nicholas Pfaff, deputy chief executive and head of sustainable finance.
"It's possible and there are discussions going on in the market around that," he said.
Preserving labels
“The current frameworks that we're using to put labels on [ESG] bonds were not intended to cover uses of proceeds around defence. We should do our best to preserve the green labels and the sustainable labels and the social labels for things that they were originally intended,” a senior ESG banker said.
“Nobody is saying we shouldn't be allowed to spend money on defence. We're just saying that this wasn't the original intent.”
With some lobbyists pushing for defence to be treated as an eligible use of proceeds, the update is the committee's first, carefully worded attempt to address a difficult question for sustainable finance.
"The objective of defence was not envisaged under any of the specified eligible project categories under the principles, although the evaluation of sustainability characteristics is not inherently incompatible with investment in defence projects or companies," according to the updated handbook.
Defence has typically been seen as ineligible for sustainable fund managers and many have exclusions on investing in the sector. However, increased defence spending is leading to a rethink in sustainable finance as the issue is increasingly reframed as security and resilience.
"After seeing the reality of war in Europe, there has certainly been some kind of reconsideration," said Thomas Thygesen, head of equity strategy at SEB Merchant Banking.
While some investment managers are willing to explore the concept of “responsible defence”, it presents definitional challenges over ownership and the type of weapons, as well as traceability issues and legislative restrictions. Dual-use technology with military and civilian purposes, such as drones, is particularly problematic.
Broader security investments, such as upgrading power grids, developing clean energy storage and protecting power supplies from cyber and hybrid attacks, as well as building European artificial intelligence, are more appealing to responsible investors.
The UK Financial Conduct Authority's sustainability rules do not prevent investment in or finance for defence companies and the European Commission has said the defence industry enhances sustainability through its contributions to resilience, security and peacekeeping.
French regulator AMF last month called for the European Commission to consider a specific category for European defence products within the European Union's Sustainable Finance Disclosure Regulation.
Nature and transition
The committee also launched a practitioner’s guide on sustainable bonds for nature, as well as biodiversity key performance indicators for nature-related SLBs.
"There [are] more and more requests to explain what investors do to manage the risk behind biodiversity and to finance some solutions. We believe it's the right time to provide this to help the market to move forward," said de Fay.
It has published additional guidance on its previous innovations – "green enabling" projects and sustainability-linked loan financing bonds.
The committee also held out the prospect of it finally launching guidance on transition bonds at ICMA's Annual Conference of the Principles in Tokyo in November.
A joint Loan Market Association/Asia Pacific Loan Market Association taskforce is expected to launch principles for transition loans.
"We are very much aware of the work the LMA is doing and we really have our thinking caps on in terms of what would be appropriate to publish," Pfaff said.
ExCom exits
Half the committee's 24 investors, issuers and underwriters were up for reelection. Most retained their spots, but CAF – Development Bank of Latin America and the Caribbean, Council of Europe Development Bank and ING have replaced Agence Francaise de Developpement, Enel and DZ Bank.