Preparedness: a new asset class?

Russia’s invasion of Ukraine has demonstrated the financial and human cost of war. But while conventional or nuclear armed conflict remains a worst-case scenario, the nature of warfare has altered dramatically in recent years.

During the Cold War, diplomacy, secret back channels and international treaties were the preferred methods of preventing conflict. 

Now, cyber-warfare – in the form of denial-of-service or hacking attacks by hostile powers – is the new frontline. It is appealing to aggressive states precisely because it is hard to attribute and hard to prevent. 

The boundaries between crime, terrorism and state aggression are blurring to such an extent that it is becoming increasingly hard to pinpoint the aggressor and harder still to prevent their actions.

Other sinister threats remain present – including targeted assassinations, chemical or biological attacks and sabotage of critical infrastructure, such as the recent attacks in the Baltic Sea. Disinformation campaigns and electoral interference are ways in which malign actors can undermine the very foundations of societies and democracy.

A health emergency, in the form of the COVID-19 pandemic, has already raised questions about societal preparedness and the need for investment up front in excess healthcare capacity. In many cases, this was found to be sorely wanting.

All these threats – conflict, information warfare, climate change and disease – call for greater resilience on the part of states, including general societal preparedness, as well as an ability to anticipate and counter new and emerging threats. 

They also imply investment and greater pressure on state budgets at a time when public finances are under unprecedented strain. New types of financial instrument are called upon – and these should be embraced by institutional investors. Greater participation by investors is urgently needed.

A recent report on European defence by former Finnish president Sauli Niinistö, states that “preparedness investments can be a boost to enhanced European competitiveness in a rapidly changing global economy” – a nod to Mario Draghi’s recent report on European competitiveness. Draghi identified a combined annual public and private sector investment need of between €750bn and €800bn for Europe to remain competitive. 

The EU itself is clearly in the frame here given its potential heft in the bond markets. Any extension of the EU’s bond issuance should be expanded to encompass not only green bonds but ‘social’ labelled bonds, whose objective should be to fund defence and social resilience projects. Unprecedented investment in renewables and electric vehicles has enabled rapid technological expansion and generation of power alongside a rapid rollout of wind and solar projects. Enhanced grid and storage capacity are still sorely needed, but the point is the clarity of the vision. 

Countries such as Finland, where arms production is largely in the hands of the state, should allow greater private sector involvement. Governments will need to identify areas where the private sector can play to its strengths, through the deployment of long-term capital. Institutional investors could get involved in common defence procurement initiatives, for stockpiling supplies or weapons. But these need coordination between states.

Defence and resilience projects and investment planning urgently need to be just as well defined as energy transition objectives are. Civil preparedness needs to expand its scope. Where in the Cold War, emergency bunkers and ration packs were the norm in some countries, current real threats to civilian infrastructure such as water, power grids, telecoms and the internet require different forms of planning and mitigation. Snipping of undersea cables in the Baltic seems like a clear warning signal that more needs to be done.

A rapid scale up of cyber resilience capacity is another area where institutional investors could participate. Venture and growth capital can play multiple roles in fostering new technology that might on the one hand boost resilience and preparedness while also serving Draghi’s European competitiveness agenda.

In 2015, the UK government fully redeemed consols (perpetual bonds) issued in 1927 to finance war debt raised in 1917. And in a time of tragic war, once more, on the European continent, defence is seen as a core foundation of our freedom and human rights. Investors who once shunned the defence sector have revised their policies or are allowing greater flexibility in the interpretation of their mandate. That recognition urgently needs to be backed by capital to boost Europe’s preparedness.

Liam Kennedy, Editor, IPE
+liam.kennedy@ipe.com