What the EU’s defence notice means for SFDR

At the finish of December 2025, the European Commission published a notice clarifying how the EU sustainable finance framework and the Corporate Sustainability Due Diligence Directive apply to the defence sector. While the notice does not introduce new legal obligations, it sfinishs a strong signal that the way SFDR, particularly Principal Adverse Impact (PAI) assessments, is being applied in practice has become overly reductive.

Zeidler Group, which offers support for investment funds law, recently delved into what the clarification means for SFDR and PAI assessments.

For investment managers, the message is not one of deregulation. Instead, the clarification reinforces the necessary for discipline and judgement in sustainability analysis, it stated.

At the core of the Commission’s position is a clear rejection of the idea that defence exposure is inherently adverse under SFDR. The regulation is designed to identify actual or potential negative impacts on environmental and social factors, not to assign blanket risk labels to entire industries. Over time, however, many market participants have treated defence as a shorthand for harm, bypassing the evidence-led assessment that SFDR requires, it stated.

Crucially, the notice does not dilute the PAI framework. Defence companies remain fully subject to all relevant PAI indicators, including those related to human rights, controversial weapons, governance standards and environmental performance. Where a company is involved in prohibited weapons, or where there is credible evidence of serious violations of international humanitarian or human rights law, negative PAI exposure remains unavoidable. The Commission’s clarification simply stresses that such conclusions must be based on analysis, not presumption.

In practical terms, this brings attribution and foreseeability to the forefront. SFDR does not require investment managers to take positions on geopolitical conflicts or to judge whether military actions are justified. Instead, it questions whether a company’s activities are credibly linked to adverse impacts, whether those impacts were foreseeable, and whether adequate mitigation was in place, Zeidler stated. Lawful sales, export control compliance and meaningful due diligence all matter in this assessment. Equally, repeated allegations, patterns of civilian harm or continued supply despite credible warning signs can materially alter a firm’s PAI conclusions.

For Article 8 and Article 9 products, the implications are sharper rather than softer. Defence exposure is not prohibited, but it must be consistent with the product’s sustainability characteristics or objectives and with how PAIs are treated across the wider portfolio. Any disconnect between stated policies, disclosures and actual investment decisions is likely to attract regulatory scrutiny.

Ultimately, the clarification is not about shielding defence from sustainability standards. It is about ensuring those standards remain credible and defensible when applied in a complex geopolitical environment.

For more insights, read the full story here.