European Defence SMEs Face Financial Hurdles: The Battle for Investment Amidst Evolving ESG Standards
As the world grows increasingly unpredictable, Europe aims for strategic autonomy in its defence capabilities by 2030. However, defence SMEs (small and medium-sized enterprises) are grappling with an uphill battle in accessing the necessary funding to fortify their operations. Why is the struggle to secure financial backing so pervasive? Let’s delve into the factors driving this narrative.
The Funding Dilemma: A Challenge for SMEs
In an era where investment is critical, many larger defence firms can secure swift resolutions from government channels when facing obstacles. For example, when one major Western European defence company encountered contract negotiations issues with an energy provider due to its military activities, they turned to trusted national government ties for a quick fix.
Conversely, smaller suppliers lack this direct access and often face significant challenges. As one anonymous representative from the defence sector conveyed, "Their local banks often refuse giving them bank accounts or loans if they supply us."
The Environmental and Social Governance (ESG) Conundrum
The rise of environmental, social, and governance (ESG) criteria complicates the landscape further. Under the EU’s taxonomy, defence activities are classified as “dirty” or unsustainable, making it increasingly difficult for SMEs that contribute to this sector to secure loans or essential services like energy provisioning and transport.
As a result, many small enterprises are caught in a vicious cycle, facing financial penalties without having the backing of high-level government support. This suppression can lead to unexpected supply chain disruptions, as highlighted by the aforementioned representative: “We might not get any notice about why a certain supplier stops supplying us with screws.”
A Rapid Shift: Opportunities Amidst Tensions
With the shadows of war looming nearby and uncertainty surrounding military support from allies, the urgency for the EU to bolster its defence capabilities is palpable. Plans are underway for EU member states to invest hundreds of billions of euros over the next few years to enhance defence systems, prioritizing sourcing from domestic firms.
The EU is keenly aware that its previous ESG frameworks, established in 2020, may hinder this progress. There is momentum toward amending these standards to ensure that European SMEs can access the funding needed to meet strategic demands.
According to Andre Keller, a partner at Strategy& Germany, a notable shift is occurring: “Over the past 12 to 24 months, a lot of ecosystem partners have proactively started to re-enter and work with defence players.” This growing investment interest stems from increased governmental defence spending and evolving risk assessments in light of geopolitical tensions.
Unlocking Investment: The Role of Policy
The European Commission aims to attract more private capital into the defence sector through the Savings and Investment Union and improvements in the Sustainable Finance Disclosures Regulation (SFDR). Additionally, the upcoming Strategic Dialogue and the Simplication Omnibus are set to streamline operational efficiencies for SMEs, ensuring they are better positioned to compete for funding.
However, for defence startups, the pathway remains fraught with complexities. Xavier Pinchart, founder and CEO of Hiraiwa, notes that “the main complexity is to find investors who can understand this sector.” This is critical, given that a startup often relies heavily on a limited customer base—typically, the government.
The Stark Funding Contrast: €2.2 Billion vs. €32.7 Million
European defence enterprises urgently need immediate orders with advance payments to allow their supply chains, including SMEs, to scale. The disparity between funding landscapes is striking: while US private equity firms invested over €2.2 billion in aerospace and defence from January 2022 to July 2023, the EU saw a meager €32.7 million in comparable investments during the same time period.
Keller points out that clearer guidelines on ESG regulations could pave the way for progress, but warns that simply adjusting the ESG framework will not suffice: “We might need to accelerate ESG standards to include an additional ‘S’ for security.” The message from stakeholders is clear: security and sustainability must harmoniously coexist.
Conclusion: A Call to Action for Europe’s Defence Sector
As the geopolitical landscape shifts, European defence SMEs find themselves at a crossroads, grappling with financing hurdles amidst evolving standards. Policymakers must act decisively to create a conducive environment for investment, ensuring that innovation, growth, and security can flourish hand-in-hand.
By bridging the funding gap and providing clarity around ESG policies, Europe could empower its defence SMEs to thrive, securing not just the future of the sector, but the safety of its citizens as well. Will the EU rise to the challenge? Only time will tell.
