This article forms part of CAER’s ‘Responsible Investment Agenda 2018 – A Work Plan for Australian and New Zealand Investors’ Report
In 2018, investors need to gear up for a deeper look at military and defence exposures beyond the screening of anti-personnel landmines and cluster munitions. The public debate around weapons in ESG-integrated and ethical portfolios are far from over when we consider the current global backdrop:
- Geopolitical pressures including the increasing aggression among governments and fear of escalation to militarised conflicts, especially in our region (South China Sea, North Korea, Myanmar), in addition to the continuing crisis in the Middle East.
- Effects of globalisation and hyper-connectedness resulting in information overload and the growing phenomenon of ‘fake news’. We also observe rising inequality in OECD countries[i] and reduced trust in public institutions[ii] across the globe.
- Escalating militarisation as indicated by an increase in international defence spending[iii] and Australia’s goal to become a top ten defence export nation.[iv]
- Landmark progress for the anti-proliferation movement as marked by the 50th Anniversary of the Treaty on the Non-Proliferation of Nuclear Weapons opening for Signature in 2018. In addition, the Australian founded ICAN (International Campaign to Abolish Nuclear Weapons) won the Nobel Peace Prize in 2017.[v]
Put this in the mix with prominent controversial weapon screening commitments in Australia and New Zealand, we have a fertile ground for a weapons and defence debate on the responsible investment agenda in 2018.
Defence is big business
Anyone who has travelled to Canberra airport knows about the prominent advertising by the defence industry in the arrival hall.[vi] While governments around the world create demand for military equipment, companies are responsible for designing and building weapons. Global defence spending is up, sales from the largest global arms companies totalled US 374.8bn in 2016.[vii] Military spending across the world is predicted to further increase in 2018.[viii]
These increasing demands coupled with rapidly developing technology drive companies to develop and evolve weapons systems. This means that companies require investors to help fund the development and production of new weapons and weapons systems. Investors in turn seek to invest in companies that have a chance of high value, long-term contracts with governments.
Government focus on local manufacturing and increased exports
With the Turnbull government announcing its Defence Export Strategy in late January, Australia is gearing up to support defence industry players to establish Australian bases specialised to deliver military services and goods to international markets. Target regions include close military allies such as New Zealand, the UK, Canada and the US, in addition to countries in the Indo-Pacific region and the Middle-East.[ix] The government has tasked the Export Finance and Insurance Corporation to administer the government’s export credit facility.
The export goal may seem overambitious at first sight, but it does make business sense. Due to Australia’s largest peacetime upgrade to armed forces[x], the Australian government requires a supply of military equipment and has pressure to procure locally where possible (the submarine debate is one high profile example[xi]). To create a competitive space of local suppliers that can maintain regular work, these companies need to diversify their customer base such as expanding to include other governments.
But here’s the catch: international military exports might open new markets, but they also open companies and their investors to a range of serious ESG risks. And while the government states “most stringent requirements are put in place through the permits process”[xii], investors are advised to carefully consider company safeguards.
In particular, companies involved in trading weapons and weapons components might be seen to contribute to uncontrolled arms proliferation that may fuel conflicts and human rights violations. Any company that is either involved in violations of international treaties or accused of being complicit in them, may face significant reputational damages. The international credibility, support, and media power that human rights organisations have should not be underestimated.
The Impact on Investment
Investors need to be aware that putting a screen on controversial weapons alone, might not provide the full solution, when considering the increasing pressures and global threats surrounding militarised conflicts. The same way the responsible investment industry puts pressure on companies for greater transparency, investors will face the same scrutiny from their clients and the broader community. The best strategy for investors who are challenged on their stance towards weapons is to be prepared by having a clear rationale for drawing the line and knowing where funds may be exposed.
Investors need to have a clear view on where and why they draw the line on military involvements: ammunition, weapons systems, the design of key components for autonomous weapons systems, superalloy components for specialised military use, combat uniforms, specialised bulletproof glass, maintenance of large equipment, building air bases, communications and communications equipment are all very different involvements. The tolerance can be varied for investors depending on their responsible investment approach and moral stance.
From an ESG integration perspective, the behaviour of companies and how they address the risk of accusations of contributing to arms proliferation or human rights abuses becomes an important factor that should be considered. ESG research, in-house or from third party sources, can help investors assess this specific risk.
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Interested in discussing any of these issues further? Feel free to get in touch.
[iii] Stockholm International Peace Research Institute, Media Release (11 December 2017): <https://www.sipri.org/media/2017/global-arms-industry-first-rise-arms-sales-2010-says-sipri>
[iv] Adam Gartrell, ‘Australia to become major defence exporter under $3.8b Turnbull plan’, The Sydney Morning Herald (28 January 2018): <https://www.smh.com.au/politics/federal/australia-to-become-major-defence-exporter-under-38b-turnbull-plan-20180128-h0pc4w.html>
[v] Nobel Prize Website, Nobel Prizes and Laureates – Peace Prizes 2017 – Award Ceremony Speech: <https://www.nobelprize.org/nobel_prizes/peace/laureates/2017/presentation-speech.html>
[vi] Paul Daley, ‘Beating the khaki drum: how Australian identity was militarised’, The Guardian (01 February 2018): <https://www.theguardian.com/australia-news/postcolonial-blog/2018/feb/01/beating-the-khaki-drum-how-australian-identity-was-militarised>
[vii] Stockholm International Peace Research Institute, Media Release (11 December 2017): <https://www.sipri.org/media/2017/global-arms-industry-first-rise-arms-sales-2010-says-sipri>
[viii] IHS Markit Press Release (18 December 2017): <http://news.ihsmarkit.com/press-release/aerospace-defense-security/global-defence-spending-hit-post-cold-war-high-2018-janes-i>
[ix] Australian Government Department of Defence Website, Strategic Policy & Intelligence – Industry – Defence Export Strategy – Global Defence Markets: <http://www.defence.gov.au/SPI/Industry/ExportStrategy/GlobalMarkets.asp>
[x] Australian Government Department of Defence, Defence Whitepaper (2016): <http://www.defence.gov.au/WhitePaper/Docs/2016-Defence-White-Paper.pdf>
[xi] Rory Callinan, ‘Questions over local input into building new submarines’, The Australian (23 June 2017) : https://www.theaustralian.com.au/national-affairs/defence/questions-over-local-input-into-building-new-submarines/news-story/14b5f07dc5a8829e41bba63e72522cc0
[xii] Prime Minister of Australia Website, Media – Doorstop – Defence Export Strategy Transcript (29 January 2018): <https://www.pm.gov.au/doorstop-defence-export-strategy>
Author: Julia Leske
CEO, Managing Director