Key Considerations for the Space and Defense Sector in an Evolving ESG Landscape

As with most nascent – albeit rapidly growing – industries, the sustainability and ESG dynamics of the sector are still very much taking shape. New space and defense technologies and innovations will support our ability to better monitor, assess, and understand the earth’s changing climate, require less telecommunications infrastructure on earth, modernize national and bi-lateral security, and offer a host of other improvements. At the same time, the rapid scaling of space and defense companies and technologies will likely lead to increasing externalities resulting from environmental impacts from operational or manufacturing activities on earth, launch emissions, and other potential issues such as the creation of space waste.

With Satellite 2022 now in the rearview mirror, below are five key ESG trends those following the space and defense sector should have on their radar for the duration of this year:

1.Space and defense companies will need to take a holistic view of their impacts on the environments of both earth and space. As the level of scrutiny around the sustainability impacts of every sector continues to grow, reports have emerged in recent years highlighting significant potential externalities of the space sector that will need to be transparently addressed with stakeholders as the sector continues to scale. However, space and defense companies will also have the opportunity to highlight the role that the sector can play in creating a more sustainable future. Morgan Stanley notes that “while increased space exploration could certainly present new sustainability issues…there are many potential benefits…The boom in data collected from space and the associated geospatial analytics could reorient market perspectives on how to approach sustainable finance in the coming years.”

2.ESG will become an increasingly important consideration in government procurement. In December 2021, President Biden signed an Executive Order directing federal agencies, including the DOD and NASA, to pursue net-zero emissions in procurement and several other environmental goals of the Biden administration. With federal government customers keen to upgrade the environmental performance of their operations, space and defense companies have a unique opportunity to set themselves apart from competitors by demonstrating their ESG and sustainability leadership.

3.In the aftermath of Russia’s invasion of Ukraine, a renewed debate has emerged surrounding how the role of defense-focused firms in preserving and maintaining national and multi-lateral security should be factored into ESG fund ratings and scoring. Although ESG-focused investors have historically screened out defense company securities from their portfolios, the rapidly shifting geopolitical situation is causing banks, fund managers, and regulators to rethink the role of aerospace and defense companies in safeguarding democracies around the world. In a recent article “Ukraine War Prompts Rethink of ESG and the Defense Sector,” the Financial Times points out that “the Ukraine crisis has shown in the starkest possible terms the risks of taking a blanket approach to an sector as crucial as defense.”

Additionally, just days after the Russian invasion of Ukraine, the European Commission published a final report outlining what constitutes social investing, excluding language in a 2021 draft of the report that would label weapons manufacturers as “socially harmful.” This is a critical development in the space and defense sector, as many of the largest businesses fall under the umbrella of defense firms that manufacture weapons.

4.A recently proposed rule from the U.S. Securities and Exchange Commission (SEC) is expected to require public companies to be more transparent in reporting their GHG footprint and anticipated impacts of climate change on their businesses. Proponents of the proposed rule predict that these stricter transparency requirements will give investors more information to inform their decisions and hold companies accountable for their contributions to climate change. The rule, which is widely viewed as groundbreaking and a major sea change in climate reporting for public companies, will touch the space and defense sector just as critically as any other. Space and defense companies need to be fully prepared to address the risks and opportunities that come with this new reporting regime.

5.ESG is quickly becoming a competitive differentiator for talent recruitment and retention. Companies with strong ESG and sustainability performance are better able to retain personnel and new attract talent in a competitive labor market for employers. Employees are increasingly looking for meaning in their work and for organizations that reflect their values, especially younger workers. A recent survey by TalentLMS and BambooHR LLC found that 58% of Gen Z employees want their company to be more environmentally responsible, and 68% find it important to work in a company that is actively committed to social causes. With a historically tight labor market and workers continuing to rethink their employment prospects, opportunities, and career paths, companies should focus on their ESG performance as a means of effectively retaining and attracting talent.

The continued rise of ESG presents fast-moving opportunities, and risks, for the space and defense sector. Firms in the space and defense sector are well-advised to follow the evolving expectations for companies concerning to sustainability and to fully integrate ESG into their governance and enterprise risk management strategies, ultimately giving them an advantage as they work to create long-term value for their stakeholders.