The European defence sector has entered “a new era of capital maturity” and the environmental, social and governance (ESG) “penalty” has come to an end, according to Houlihan Lokey.
In its 2026 European Defence Market Update, the global investment bank reported that the sector had left “the speculative fervour of 2025 behind for a disciplined pursuit of value realisation”.
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Private markets are “injecting record capital”, with venture funding for European defence and security startups having reached €7.4bn (£6.4bn) in 2025, a 55 per cent year-on-year increase.
Houlihan Lokey said that 2025 marked the “decoupling of ‘defence equity’ from ‘defence credit’”.
“Credit investors are now rewarding companies that demonstrate an ability to translate record order books into efficient production and margin growth. Evidence of improved operational efficiency and the successful integration of new technologies is seen as the next driver for further spread tightening,” the investment bank said.
The update also pointed to a new market classification introduced by Euronext last year, which is designed to “bring structure and transparency” to capital raising within the aerospace and defence sector.
The European Defence Bond Label also addresses the “uncertainty” surrounding defence-related instruments in ESG-oriented portfolios.
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“By formalising how defence debt is categorised, the framework aims to improve capital access for companies contributing to national and EU-level security priorities, offering an alternative to reliance on bank lending or government funding,” the firm stated in its update.
“The ‘ESG penalty’ that historically constrained investment into defence is now reversing, giving way to a clear ‘security dividend’ across capital markets,” said Géraud Estrangin, a managing director in Houlihan Lokey’s Industrials Group.
“Defence is increasingly being treated as essential infrastructure rather than a peripheral or cyclical allocation, prompting a broad re-rating from both equity and credit investors. This shift is underpinned by unprecedented visibility on government spending, record order backlogs, and a clear political mandate to rebuild Europe’s defence industrial base,” he added.
Asset managers have increasingly been looking to fund the defence space. Earlier this month, BNP Paribas announced that it had increased its support for the defence sector last year, committing an additional €6.5bn in investments and €2bn in financing.
And private credit firms in particular are making moves to finance the defence supply chain.
For example, Sienna Investment Managers announced last September that it had raised over €270m in commitments for a dedicated strategy targeting small- and medium-sized enterprises (SMEs) and mid-caps in a first close. The fund is targeting up to €1bn by the end of 2026.
There are also wider industry efforts to encourage private funding of European defence projects.
Last year, law firm Travers Smith called on European governments to implement structural reforms to attract private capital support for European defence funding targets.
