Tapping Financial Markets to Fund the EU’s Defence Capability?

The geopolitical and security context that Europe currently finds itself in is clear to everyone. European defence capability is suffering from decades of under-investment and Europe is generally proving to be unprepared for a major and sustained military conflict on the continent.[1] Instilling more dynamism in its defence industry is becoming a key policy priority. However, Europe’s defence equipment production capacity remains highly fragmented due to power politics among the member states.

The single European market in defence goods is to a large extent non-existent. There is a lack of mutual recognition, a lack of interoperability and a patent absence of standardisation, all of which indicate that economies of scale for European industrial players cannot currently be exploited. In addition, being particularly exposed to an industry that is structured by a few giants and myriad small and medium-sized enterprises (SMEs), the EU has only just started to reflect on how closer collaboration could leverage the development of common military goods or ammunition. This is today’s ‘physical’ reality, one may say.

What about the financial reality? National budgets have historically been the backbone of defence funding. The current debate on the share of NATO members’ GDP (whether 2%, 3% or 5%) dedicated to defence perfectly illustrates the persistent expectation that defence spending depends on national taxpayers. But some action at the EU level has also taken place more recently with the creation of the EDF, the European Defence Fund, an 8 bn euro fund for the period 2021-2027 that “supports companies across Member States to develop competitive and collaborative defence projects that will deliver innovative and interoperable defence technologies and equipment” (EU, 2024). Two other financial programmes, the Act in Support of Ammunition Production (ASAP) and the European Defense Industry Programme (EDIP), complement the EDF but in the grand scheme of things it is fair to say that the EU Defence Union still remains in its infancy.

In the coming years the policy debate is likely to dedicate more attention to the contribution of financial markets to the development of an EU Defence Union and more broadly of EU defence capability. However, asking how to finance Europe’s defence industry in reality amounts to asking a larger question: how can a larger number of European firms access finance? DG DEFIS at the European Commission commissioned a study on this last year. One of the study’s illuminating findings is that “SMEs operating within the defence sector still face higher barriers to accessing finance than in other sectors. According to the survey, approximately 40% of the SMEs found access to finance to be either difficult or very difficult” (EC, 2024[2]) and more recently firms in the sector have proven unwilling to even try to access debt and equity financing. The Noyer Report on the Capital Markets Union also concluded that for the defence industry to scale up, “boosting production-chain capacity and resilience will necessitate significant private-sector investment, particularly in the form of equity financing” (Noyer, 2024: 12).

If Europe is to fulfil its high ambitions in terms of sustainability, digitalisation, strategic industrial autonomy and defence, SME access to finance ought to be a key policy priority for the new European Commission.

[1] https://www.bloomberg.com/graphics/2024-nato-armed-forces/

[2] https://defence-industry-space.ec.europa.eu/study-results-access-equity-financing-european-defence-smes-2024-01-11_en