Private credit firms are exploring whether they can ease environmental, social, and governance (ESG) restrictions in order to finance Europe’s expanding defence industry, a sector that has become a strategic priority for governments, especially amid growing concerns over European rearmament.
The issue has gained prominence as European nations grapple with the increasing urgency to bolster their defence capabilities, partly in response to threats from President Donald Trump’s previous stance on curtailing US support for the continent. While smaller private funds have already started financing defence companies, many larger funds are constrained by ESG requirements that prohibit lending to weapons and munitions manufacturers.
However, these restrictions are now being questioned by both industry leaders and government officials, as Europe’s security needs continue to grow. “In France, there has been a big initiative under the Ministry of Economy and Finance to encourage private assets and asset management companies to be more open-minded about defence investment,” said Cécile Mayer-Lévi, head of private debt at Tikehau Capital, which manages nearly €50 billion in assets. The firm has financed several defence companies over the last five years.
Mayer-Lévi added that French officials have urged investors to “accelerate change in their documentation and the bylaws of the fund, so that defence is eligible.” As European governments prioritize military expansion and rearmament, they are increasingly pressuring the private credit sector to adapt.
While some credit funds have been able to lend to the defence sector, particularly for companies with higher yields or strong growth potential, others face significant barriers. One credit fund manager explained that most European collateralized loan obligations (CLOs)—large investment vehicles that provide funding to riskier companies—cannot legally fund defence companies. Even hedge funds are encountering challenges if they have institutional investors with ESG policies that prohibit such investments. According to PitchBook, European CLOs manage approximately €250 billion in assets.
“Defence, especially for Europe, is a place where we are still scratching our heads,” the credit fund manager remarked, noting the shift in attitudes towards defence investments. Rating agencies, many of which provide ESG scores, are also under pressure from European governments to reassess the sector and facilitate funding.
Credit funds that have successfully provided capital to the defence industry have been rewarded with high returns. For example, in November 2023, Czechoslovak Group (CSG), one of Europe’s largest ammunition makers, raised $775 million in bonds, offering buyers an interest rate exceeding 11 percent. The bond was sold to private credit firms, and part of the proceeds were used to refinance debt following CSG’s acquisition of US rival Kinetic.
“We’re surprised at how single-minded some of our peers have been,” said a portfolio manager at a credit hedge fund that has lent to defence companies. “There’s a lot of tick-box ESG,” they noted, adding that higher yields, even without increased credit risk, make the sector an attractive investment.
Several companies within the defence sector that have previously borrowed from individual private credit firms are now seeking to engage with multiple lenders as interest in financing the industry continues to grow. Survitec, a company that provides safety equipment for fighter pilots, previously secured £270 million from Ares Management in 2021. Mehler Systems, a manufacturer of ballistic and tactical equipment, also borrowed from private credit firm Barings in 2020.
Survitec and Mehler did not respond to requests for comment, while Ares and Barings declined to provide any remarks.
In a conversation with The Financial Times earlier this year, Admiral Rob Bauer, former chair of NATO’s military committee, voiced his frustration with rating agencies, banks, and pension funds that refuse to invest in defence. “If you are looking at return on investment… there’s so much money to be spent over the next 20 years,” he said, criticizing the reluctance to back a vital sector that could offer substantial returns.
This growing debate over the financing of Europe’s defence sector highlights the increasing importance of private credit firms in meeting the continent’s security needs. As geopolitical tensions rise and military spending escalates, the question remains whether ESG policies will evolve to support this crucial industry, or whether investors will continue to shy away from defence-related opportunities.
