Russia's invasion of Ukraine is prompting investors to consider pivotal ESG opportunities in the defense industry. Asset owners are reviewing their ESG impact strategy and applications, citing investment in Ukraine's defense capabilities as a recent example. Morningstar Sustainalytics' research teams are actively engaged in innovation within their respective areas of expertise. Members of Morningstar Sustainalytics’ research team attended Eurosatory1 to discover the latest industry developments and understand the sector’s anticipated future state.
Insights from the conference are intended to increase investors’ awareness of ESG factors in defense trends and help identify risks that may require consideration in investment or engagement processes. Our key takeaways from this global event revolve around three main areas listed below.
Climate Change Impacts on the Defense Industry
While perhaps not a widely considered link between the defense industry and climate change, several Eurosatory conference sessions addressed how climate change can intensify security risks and threats. This could include a lack of water access due to desertification, food scarcity resulting from less precipitation, and loss of crops because of heat-resistant pests. Respectively, we consider what this means for the survival of the fittest and the battle for resources. Military organizations are often mobilized to help citizens deal with the aftermath of natural disasters induced by climate change.
Moreover, the defense industry should address its challenges related to climate change. Critical actions can include establishing a sustainable supply chain, reducing its carbon footprint, conducting in-depth product lifecycles analyses (i.e., create/adopt engines compliant with biofuel or e-fuel, make equipment lighter, use hybrid tech), and considering eco-design in its products. Collaboration across sectors is key to sharing energy-transition knowledge for defense organizations so as not to stay behind other industries which tackle the energy transition needed to keep the planet sustainably secure.
Defense Industry Innovation
Innovation is vital for the sector to address climate change-related risks (i.e., the use of ‘’frugal AI’’ that consumes less energy) and explore how militaries can sustainably improve surveillance and intervention. A noteworthy exhibit at the conference questioned the effectiveness of drones and various robots, specifically contemplating the future implications of autonomy.
During a conference session titled Sustainability as a National Security Imperative, Raphaël Desi, Vice President of Strategy and Marketing at Thales Global, mentioned that ‘’operational effectiveness is a top priority and safeguarding the life of the soldier should come first.” Therefore, robots will be used if tech innovation can achieve this aim. One example provided was to fully integrate drones within a vehicle, eliminating the need for anyone to go out and become vulnerable by manipulating the drone externally.. Further, surveillance machines can also start reading license plates to compare them against a database, triggering a signal for something that is not right. Or we can talk about drone solutions for firefighters, where one needs proper intel on where a fire goes (left or right?) and potentially acquiring knowledge on what happens inside a burning building without putting oneself in danger. Innovation can leverage protection and better data and analysis to balance brute power and technological dominance.
Cybersecurity Considerations Vital in the Future of Defense
Innovation is also linked to cybersecurity, which no longer represents a virus-to-virus computer attack risk. When discussing conflicts, it is essential to understand that the cyber world is connected to the real world and vice-versa. While an attack on a power plant may not be able to steal data, a company’s lack of hardware cybersecurity knowledge could make it possible to shut down or cause damage to physical systems.
A recommendation from the conference was to address: systems which are not always up to date or always patchable, not running well-known operating systems or not always able to defend themselves (sometimes impossible to install anti-malware). Thus, when building new infrastructure (be it used for military purposes or not), they need to consider ‘cyber secure-by-design’ proposals as well.
While the conference focused mostly on the European land defense industry, the main themes are applicable to other military players worldwide. The Eurosatory facilitated knowledge sharing regarding ESG factors to enable proper preparedness ahead of potential conflict, for both public and private sectors, from an opportunity and sustainability point of view. With expensive equipment, high inflation, human capital skillset at peril, lack of manufacturing capabilities and climate change knocking at the door, the industry needs to become more resilient and dynamic. The conference provided a conducive environment for constructive dialogue around ESG applications for the Defense industry, in turn facilitating helpful insight for investors to analyze portfolio exposure.
Morningstar Sustainalytics’ Defense Research enables investors to screen companies involved in military contracting. Get in touch to discuss potential impacts on your portfolio.
Notes:
1. Eurosatory is a global defense and security exhibition held every two years in France. National representatives, manufacturers, and official military delegations showcase and debate the latest air and land military and emergency threat trends. The conference took place over four days, showcasing life-size equipment, including armored vehicles, tanks, launching systems, and drones. Other weapons were also exhibited, including small arms, assault weapons, white phosphorus ammunition, and more.
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