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Private credit firms are looking into easing the sustainable investment standards set by their backers so they can provide essential funding to Europe’s growing defence sector.
Funding for Europe’s defense industry has become increasingly important, especially after President Donald Trump suggested the US might reduce its support for Europe.
While some smaller funds can finance the sector, many are constrained by environmental, social, and governance (ESG) regulations imposed by their investors that restrict lending to manufacturers of weapons and munitions.
However, both the industry and government officials are starting to challenge these constraints as European rearmament gains urgency.
Cécile Mayer-Lévi, head of private debt at Tikehau Capital, which manages almost €50 billion in assets and has financed several defense firms in recent years, stated, “In France, we see a significant push from the economy and finance ministry to encourage private assets and asset management firms to be more receptive to defense investments.”
She also noted that French authorities have urged investors to “speed up changes in their documents and fund rules so that defense investments are permissible.”
A credit fund manager mentioned that most European collateralized loan obligations—major lenders to companies with lower credit ratings—“can’t invest in” defense companies. Even hedge funds face obstacles if they have institutional investors prohibiting defense investments. According to PitchBook, European CLOs manage around €250 billion in assets.
Discussing investments in defense, he remarked, “This sector is still a puzzle for us, especially in Europe, as we navigate changes in perspectives.”
He added that rating agencies, many of which also provide ESG ratings, are facing pressure from European governments to reassess the sector to facilitate lending.
Credit funds that successfully invest in the defense sector have enjoyed annual returns in the double digits. For instance, Czechoslovak Group (CSG), a large ammunition manufacturer, raised $775 million in bonds last November, offering investors an interest rate exceeding 11 percent.
This bond, which partially refinanced debt after CSG acquired US competitor Kinetic, was primarily sold to private credit firms, according to a source familiar with the transaction.
A portfolio manager from a credit hedge fund that has lent to defense firms expressed surprise at the narrow focus of some peers. “Many use a box-checking approach to ESG,” they noted, adding that if better yields could be achieved without additional credit risk, “that’s an opportunity we’ll consider.”
Companies in the defense sector that have previously borrowed from single private credit sources are now starting to engage multiple lenders due to an increasing interest in this sector, according to sources close to the situation.
For example, Survitec, a provider of safety gear for F-35 fighter pilots, previously borrowed £270 million from Ares Management in 2021. Another firm, Mehler Systems, which makes ballistic and tactical gear for military personnel, secured financing from private credit specialist Barings in 2020.
Requests for comments from Survitec and Mehler went unanswered. Both Ares and Barings declined to comment.
In January, Admiral Rob Bauer, then chair of NATO’s military committee, criticized rating agencies, banks, and pension funds for avoiding defense investments, calling it “foolish.” “With significant investment opportunities over the next 20 years, there’s a lot of money waiting to be spent,” he asserted.
