In recent years, investment companies have increasingly turned their attention to the defense and dual-use technology sectors, recognizing the growth potential amid evolving geopolitical dynamics. However, navigating this space presents a unique set of challenges. Investors must balance profit-driven decisions with ethical considerations, all while complying with stringent regulatory and ESG standards. This article serves as a practical guide for investment firms looking to engage with the defense and high-tech sectors, offering strategies to mitigate risks and align with export controls and ESG principles. It examines both the challenges and financial incentives, such as the "Defence Equity Facility" and the Ramp-up Fund, designed to help investors manage risk and maximize returns. For both investors and industry players, the article outlines actionable strategies to leverage the sector's momentum, attract investment, and reduce associated risks. This article builds on a previous RSM article, which explored the complex relationship between investors and the defense, deeptech, and dual-use sectors.  

Investing in Defense & Dual-Use Technologies: ESG Challenges to Attract Capital 

As a result of the institutional shift that took place in last 1-2 years, private equity firms have started to actively engage in the defense and dual-use technology sectors. However, the influx of capital into defense and dual-use technologies presents a complex landscape for investors. Despite the shift that took place, investors are still expected to balance profit motives with ethical considerations, regulatory compliance, and ESG criteria.  

Many institutional investors, including sovereign wealth funds and pension funds, have strict ESG policies that discourage or prohibit investments in military and dual-use technologies. This can result in limited exit opportunities for private equity firms, as fewer buyers may be willing to acquire defense-related or dual use assets. The EU’s sustainable finance rules also require investors to explain how they handle sustainability risks and set basic social standards that are seen as conflicting with social sustainability. Under the Sustainable Finance Disclosure Regulation (SFDR), financial institutions must report their “exposure to controversial weapons,” which are considered unsustainable. Aside from activities banned by international agreements, most defence-related activities are not automatically seen as socially unsustainable by investors. Some investors still choose to exclude defence-related activities for social sustainability reasons, even when other factors, like fair treatment of workers, are met. The EU has also created a classification system for “environmentally sustainable” economic activities through the EU Taxonomy. So far, no specific defence-related activities have been included. As a result, like many other industries, the defence sector cannot show alignment with the Taxonomy, except for certain general activities like construction and transport.

On the other hand, the European Commission remains committed to ensuring that the defense industry contributes to the EU’s green transition. The European Defence Technological and Industrial Base (EDTIB) is expected to enhance sustainability by reducing carbon emissions, increasing circularity, and integrating renewable energy solutions in line with EU climate policies. The Commission will continue supporting these efforts through initiatives such as Green Procurement and fostering synergies between Member States, industry, and EU climate policies. Additionally, the Commission is pushing for financial sector engagement by inviting the EIB to review its defense-related lending policies and providing guidance on applying the EU sustainable finance framework. Future EU funding programs will also consider sustainability and defense resilience, reinforcing the expectation that the industry aligns with environmental objectives while maintaining security and operational readiness.  EU support through budgetary guarantees can help address market failures, either by providing direct funding or encouraging private investment. The EU mainly uses financial tools under InvestEU through the European Investment Bank (EIB) Group -which includes the EIB and the European Investment Fund (EIF)- and, to a lesser extent, through other multinational or national promotional banks. Defence is recognized as an eligible and strategic sector under InvestEU. To boost this, the Commission proposed adding funds to InvestEU to create the "Defence Equity Facility," which would provide equity -through the EIF- to venture capital or private equity funds investing in defence-related technologies with dual-use potential. Additionally, the ASAP Regulation allows for the creation of a Ramp-up Fund, a blending facility that offers debt solutions to attract investment, reduce risk, and speed up the expansion of manufacturing capacities. 

Strategies for Investors and Industry Players 

With growing demand for military and high-tech dual-use items, coupled with incentives from the EU and Member States, investors should reconsider their stance, as concerns around the social and governance aspects of ESG can be effectively addressed by industry players. Furthermore, with a robust KYC and due diligence process for potential investee entities, investors can address these concerns and effectively mitigate risks:

  • Strategies for investment companies

Investment companies looking to invest in entities involved in military and dual-use items should evaluate the following aspects based on the EU Common Military Position criteria. Investment companies should carefully vet military and dual-use entities to ensure they comply with international laws, uphold human rights, maintain regional stability, and do not contribute to conflict, terrorism, or economic instability. Investors should confirm that the company follows EU regulatory requirements, including EU Common Position on Arms Exports and EU Dual-Use Regulation. Companies must conduct thorough due diligence on buyers to prevent misuse of exported goods, which implies that investment companies should assess the maturity and effectiveness of screening operations of the investee entity.

Investors should monitor new EU rules on emerging threats, such as cyber warfare and AI, which could affect compliance requirements. On 3 October 2023, the European Commission adopted a Recommendation on critical technology areas for the EU's economic security. Out of the ten critical technology areas, the Recommendation identifies four technology areas that are considered highly likely to present the most sensitive and immediate risks, including quantum technologies (quantum computing, quantum cryptography, quantum communications, quantum sensing and radar) and advanced semiconductors technologies (microelectronics, photonics, high frequency chips, semiconductor manufacturing equipment).  Moreover, certain EU Member State enforces additional rules, often stricter than EU-wide regulations, depending on geopolitical concerns. For example, on 18 October 2024, the Dutch government announced supplemental controls for exports of certain emerging technology items from the Netherlands.

For investments in companies dealing with U.S. military or dual-use technology, investors must check compliance with International Traffic in Arms Regulations (ITAR) and Export Administration Regulations (EAR). These rules apply globally, meaning even non-U.S. companies handling American-origin goods, components, or technology must comply.

For the deficiencies identified during the due diligence over the potential investee entities, investors should draft and negotiate contractual clauses requiring companies to craft and implement an Internal Compliance Program in line with the regulatory guidelines while especially addressing the deficiencies. Investors can develop a post-investment engagement policy for continuous monitoring of investees to assess the implementation of measures identified in the pre-contractual clauses. This could include regular audits, compliance reviews, and periodic reporting to ensure ongoing compliance.

  • Strategies for companies in defense & dual-use technologies

From an investee perspective, investors should require their portfolio companies to implement robust internal compliance programs that ensure adherence to the export control regulations. This includes conducting thorough due diligence, employee training, and continuous monitoring of transactions to prevent violations. To reinforce these commitments, investors should incorporate stringent contractual clauses in investment agreements, mandating compliance with export regulations and allowing for regular audits or reporting requirements. These provisions not only mitigate legal and financial risks but also provide a mechanism for investors to take corrective action if compliance failures arise. Ultimately, these measures create more value for both investors and investees by minimizing legal and reputational risks, ensuring long-term sustainability, and fostering trust with stakeholders.

Building upon the previous recommendations, the establishment of a comprehensive internal compliance program should serve as the cornerstone of an organization's risk management strategy. To strengthen its compliance framework and elevate the policy to meet regulatory standards, companies should benefit from incorporating the elements outlined in regulatory guidelines, such as:  

The Internal Compliance Program should be consist of at least with the following elements:  

  • Top-level management commitment to compliance  
  • Organisation structure, responsibilities and resources  
  • Training and awareness raising  
  • Export screening process and procedures  
  • Performance review, audits, reporting and corrective actions  
  • Recordkeeping and documentation  
  • Physical and information security  

The internal compliance program should include dedicated compliance leadership, such as a Chief Compliance Officer with direct reporting lines to senior management and the board of directors. Regular risk assessments, detailed mapping of technology and product export pathways, and screening processes (that enable real-time monitoring, automated compliance checks, and recordkeeping) for transactions and potential partners become essential components. 

Forward Thinking 

As the defense and dual-use technology sectors continue to evolve, driven by growing demand and strategic incentives from the EU and Member States, investors will face both significant opportunities and challenges. The future of defense and dual-use investments will require stronger collaboration between the public and private sectors. Governments, through initiatives like the EU’s defense funding programs, will continue to play an instrumental role in shaping the landscape. Investors can benefit from these partnerships by aligning with government-supported projects and leveraging financial instruments designed to boost the defense sector’s resilience and innovation. As defense and dual-use technologies become more sophisticated, particularly with the advent of AI, quantum computing, and other advanced technologies, investors should prepare for rapid innovation cycles. Companies in this space will need to develop strategies to manage the risks associated with these technologies. Investors must ensure that their portfolio companies have the necessary technological capabilities and internal controls to handle emerging risks while capitalizing on new opportunities.

The future of investment in defense and dual-use technologies presents an exciting yet complex terrain. By adopting a proactive approach to regulatory compliance, embracing sustainability efforts, and strengthening internal risk management frameworks, investors can navigate these challenges and unlock the full potential of the sector. Ultimately, those who successfully balance financial returns with responsible investing will be best positioned to capitalize on opportunities while mitigating reputational, legal, and regulatory risks.

RSM is a thought leader in the field of Strategy and International Trade consulting. We offer frequent insights through training and sharing of thought leadership based on a detailed knowledge of industry developments and practical applications in working with our customers. If you want to know more, please contact our partner, Mario van den Broek via [email protected].