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Controversial Weapons: Regulatory Landscape and Best Practices

Posted on June 5, 2019

Dora Cristian
Dora Cristian
Weapons Research Manager
Anne Schoemaker
Anne Schoemaker
Director, ESG Products

Since the beginning of modern warfare in the 20th century, we have witnessed the development of weapon types that have a severe, disproportionate and indiscriminate impact on civilians, even years after a conflict has ended. Over the past decades, several protest movements have attempted to halt and ban the production of specific, controversial weapon types, and many countries have adopted international conventions to this effect. More recently, some financial institutions have begun to restrict or exclude financing of companies with involvement in certain weapons. This article explores what investors can do, beyond existing legal frameworks, with respect to controversial weapons.

Sustainalytics’ definition of controversial weapons

There is no universally accepted definition of controversial weapons and thus the one used by various public and private actors differs.

Under Sustainalytics’ methodology, certain weapons are considered controversial due to their disproportionate and indiscriminate impact on civilians, even years after a conflict has ended. The principles of ‘distinction’ and ‘proportionality’ are key concepts in international humanitarian law, which regulates the methods, as well as the means, of warfare[1].

We include anti-personnel mines, nuclear weapons, cluster weapons, biological and chemical weapons, depleted uranium, and white phosphorus munitions in our controversial weapons research.

International and national regulatory context

Most weapons commonly considered controversial are subject to international treaties such as the Convention on Cluster Munitions and the Anti-Personnel Mine Ban Convention. These conventions generally prohibit the development, production, acquisition, stockpiling, transfer and use in armed conflict of weapons and methods of warfare causing unnecessary injury or suffering. The majority of countries globally have signed and ratified these international treaties.

However, these conventions do not address the issue of investment in controversial weapons, including the financing of their development, manufacture, sale and/or acquisition.

A growing number of countries have stated that they interpret the conventions’ text on to include the prohibition of (certain types of) investments, but overall the vast majority of countries have no or very limited legal frameworks in place that govern investment in companies involved in controversial weapons.

Please stay tuned for our Sustainalytics White Paper on the Regulatory Context of Controversial Weapons, which will contain detailed information on national and international legislation concerning controversial weapons.

Recent developments

The lack of an (inter)national legal framework for controversial weapons leads investors to adopt different investment policies and approaches. As a result, the nature and extent of investors’ responsible investment policies determine the flow of money to a sector generally perceived to be incompatible with a just and sustainable world.

Beyond the policy level, responsible investors also have an important role to play in pushing the exclusion of companies involved in controversial weapons into the mainstream financial industry. The start of 2019 brought an interesting development in that respect: a group of institutional investors managing USD 6.8 trillion in assets called on global index providers “to exclude controversial weapons from their mainstream indices in order to align their products with what has become standard practice or expectation among institutional and individual investors” (see the open letter here). Active investors that exclude companies involved in controversial weapons face tracking errors and other costs when following mainstream indexes that include these companies. In addition, passive investors may be unwillingly contributing to the financing of companies involved in controversial weapons.

This investor initiative demonstrates that more effort is needed to fully bring controversial weapons exclusion into the mainstream, even though this investment strategy is not new, and despite the fact that as of 15 October 2017 the UN Global Compact excludes companies with involvement in nuclear, chemical and biological weapons.

Best practices for investors

Financial institutions generally exclude companies involved in controversial weapons for the following reasons:

  • Compliance with international and national legislation.
  • In response to pressure from civil society and the media.
  • To meet client demands.
  • Their own ethical convictions.

In addition to the obvious compliance and reputational risks involved with exposure to this industry, there are also financial risks to consider. For example, when regulatory developments or external or shareholder pressure forces divestment on short notice.

Investors can mitigate these risks by implementing the following best practices:

  • Develop a clear and comprehensive weapons exclusion policy.
  • Actively engage with companies involved in controversial weapons.
  • Participate in sector initiatives to influence standard practice in the investment industry.

Develop a weapons exclusion policy

In general, financial institutions focus their efforts on assets they actively manage themselves. However, we see that an increasing number of responsible investors also apply their policies and exclusion lists to their external managers and to passively managed assets.

Policy practices differ significantly across geographies, as they are primarily driven by applicable national regulatory frameworks and depend on the maturity of individual responsible investment markets. Nonetheless, at a minimum, investors should:

  1. Evaluate and incorporate relevant international and national legislation;
  2. Understand associated risks and exposure;
  3. Carefully define the scope of their weapons policy; and
  4. Monitor new developments in the industry and develop and implement appropriate responses.

With respect to the scope of the policy, the following dimensions can be considered:

  • Financing activities: Active equity investments are often the minimum of what is within scope of an exclusion policy, but it can be extended to other asset classes and forms of investment, financing, and other banking relationships. Extending the policy to any external or third-party asset managers can also be considered.
  • Weapon types: Investors could consider aligning their policies with the principles of international humanitarian law but go beyond the specific conventions. This can be achieved by including in their policy controversial weapons that are not prohibited by legislation, selected based on wide-spread controversies and initiatives for prohibiting such weapons (such as white phosphorus). Specifically, investors in the United States (which is not a signatory to some of the relevant international conventions) can consider going beyond their national legal framework when developing their exclusion policies.
  • Ownership relations of involved companies: Exclusions can be extended to include subsidiaries and even parents of involved companies, with or without ownership thresholds.
  • Other criteria: Policies can be further refined to include specific criteria such as the exclusion of certain dual-use components and services.

Actively engage

Although engagement with companies is not usually undertaken in sectors involved in controversial activities, we do see anecdotal evidence that investor pressure can lead to defense companies ceasing their involvement with certain weapon types. As such, investors may decide to actively engage with companies in the Aerospace and Defense industry regarding initiatives and commitments to not develop, produce, stockpile, use, maintain, repair, and/or sell controversial weapons. CSR or annual reports, as well as reports by civil society organizations such as PAX, can support the monitoring of such commitments.

Participate in sector initiatives

Lastly, investors can raise awareness about the impact of controversial weapons, collaborate with relevant civil society organizations, and push for sector-wide actions and initiatives (such as the letter to index providers mentioned earlier. Click here if you are interested in joining this initiative). These initiatives can ultimately lead to a more broad-based and standardized exclusion of companies involved in controversial weapons.

Learn more about how Sustainalytics’ Controversial Weapons Radar can support your investment approach. 

[1] Some organizations also use illegality to define controversial weapons. Under that definition white phosphorus and depleted uranium would not be captured as there are no international conventions in place for these weapons types.

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