This year’s Munich Security Conference reemphasized the need for Europe to invest in greater defense capabilities and foster a regulatory environment that is conducive to building a defense and technological industrial base. In Munich, President Ursula von der Leyen committed to appointing a European Commissioner for Defence, if she is reselected later this year by the European Council and European Parliament. And the EU is also due to publish shortly a new defense industrial strategy, mirroring in part, the first-ever U.S. National Defense Industrial Strategy (NDIS) released earlier this year by the Department of Defense.
The NDIS, in turn, recognizes the need for a strong defense industry in both the U.S. and the EU, as well as other allies and partners across the globe, in order to strengthen supply chain resilience and ensure the production and delivery of critical defense supplies. And global leaders generally see the imperative of working together over the long-term to advance integrated deterrence policies and to strengthen and modernize defense industrial base ecosystems. We will continue tracking these geopolitical trends, which are likely to persist regardless of electoral outcomes in Europe or the United States.
These developments across both sides of the Atlantic follow on a number of significant new funding streams in Europe over the past couple of years, for instance:
- The 2021 revision of the European Defense Fund Regulation allocated €8 billion for common research and development projects, meant to be spent during the 2021-2027 multi-annual financial framework (MFF).
- As a direct response to Ukraine’s request for assistance with the supply of 155 mm-caliber artillery rounds, the EU adopted the 2023 Act in Support of Ammunition Production (ASAP), with a €500 million fund to scale up production of ammunition and missiles.
- Most recently, the EU adopted the 2023 European Defense Industry Reinforcement through Common Procurement Act (EDIRPA), introduced a joint procurement fund of €300 million to facilitate Member States’ collective acquisition of defense products.
- The European Peace Facility (EPF), an off-budget instrument, with an overall financial ceiling exceeding €12 billion, is primarily destined toward procurement of military material and large-scale financing of weapon supplies to allied third countries (including €6.1 billion for Ukraine).
Even deeper beneath these policy headlines, discussions at the Munich Security Conference also raised several new issues surrounding the intersections of defense and ESG. Beyond allocating additional resources for defense and innovation and strategizing regarding their use, the EU is also considering other available regulatory ways to facilitate the defense industrialization of Europe.
Indeed, a number of existing legal tools may provide a useful source of authority. In particular, a new “Defense Taxonomy,” which builds on the existing environmentally-concerned Taxonomy Regulation, could provide the necessary incentive mechanism to boost production and help bolster European security.
The Taxonomy Regulation is an important tool in the European Commission’s arsenal to achieve the objectives of the Green Deal, which also aligns with the U.S. National Defense Strategy’s goals to work with allies and partners in tackling climate change. The Regulation establishes a classifications system of economic activities that distinguishes between activities that are environmentally sustainable (i.e., Taxonomy-aligned) and those that are not (i.e., Taxonomy-eligible). The Taxonomy classification creates a tested and reliable source of information that investors, asset managers, and other financial market participants can use to direct their funding into economic activities that contribute to reducing greenhouse gas emissions, environmental sustainability, and to moving the EU closer to its goal of becoming net-zero by 2050.
In a similar vein, establishing a “Defense Taxonomy” would likely allow investors to make green investments, while contributing to Europe’s security infrastructure; and it would enable the European Commission to combine two of its key policy priorities: the Green Deal and the upcoming European Defense Industry Strategy.
Currently, with environmental concerns in mind, the Taxonomy Regulation covers economic activities that make a “substantial contribution” to one of six environmental objectives. These objectives are: (i) climate change mitigation; (ii) climate change adaptation; (iii) sustainable use and protection of water and marine resources; (iv) transition to a circular economy; (v) pollution prevention and control; and (vi) protection and restoration of biodiversity and ecosystems. In addition to making a substantial contribution to one of the six environmental objectives, the Taxonomy Regulation also requires that an economic activity “does no significant harm” (“DNSH”) to any of the other environmental objectives, and complies with a number of minimum safeguards. Manufacturing of defense-related equipment is currently not included as an economic activity considered to make a substantial contribution to any of these six objectives, although certain aspects of defense-related production may be covered.
Considering the current structure of the Taxonomy Regulation, a “Defense Taxonomy” could take one of two forms. First, the Taxonomy Regulation could be amended to include “defense-related manufacturing” as a Taxonomy-eligible economic activity under either the Climate or Environmental Delegated Act. This is likely the simplest way to include defense-related economic activities into the Taxonomy framework, as it would require only minimal amendments to existing legislation. It would also provide a considerable degree of flexibility, as more than one defense-related economic activity could be included. One difficulty with this approach may be in deciding what constitutes a defense-related economic activity, especially considering classification systems only include a limited number of defense-related activities. Nevertheless, the Complementary Climate Delegated Act, which introduced the construction of nuclear power plants as a Taxonomy-eligible economic activity, provides a useful precedent for this approach.
Second, a standalone Taxonomy Framework that builds on the legislative structure of the existing Taxonomy Regulation may allow for the scale up of European defense production capabilities. This approach would provide the greatest degree of flexibility and allow the European Commission to tailor the relevant criteria to the specific requirements of the European defense industry. This approach would also allow for the Commission to establish new objectives, which could focus less on making substantial contributions to environmental matters, and focus more on defense-related metrics. For example, this could include the ability of an economic activity to make a substantial contribution to European air-defense capabilities (e.g, develop a new surface to air missile); that it provides employment in otherwise economically deprived areas (e.g., establish ammunition factories in specific areas); or contributes to the cohesion of EU military capabilities (e.g., development of a common EU frigate class). Naturally, a defense-specific taxonomy would be the most effective in scaling up European defense production.
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National security in Europe and the United States, as well as more broadly, includes now not only defense and military policy, but also tech policy and other regulatory areas (such as ESG) that impacts the development of underlying capabilities to provide for collective security. The team at Covington, which cuts across a wide range of regulatory areas, is well placed to advise you on these policy developments, and how to engage with the relevant decision-makers on these questions.