Future of Defence ETF Report | March 2024

Defence ETF Key Takeaways

After months of delays, Sweden to join NATO – After 18 months of delays while Turkey and Hungary held up ratification and sought concessions from other members, Sweden will be joining NATO. This move leaves a 200-year history of Swedish neutrality behind it. Sweden, like neighbor Finland, had avoided seeking NATO membership, but that stance changed virtually overnight when Russia launched its invasion of Ukraine in February 2022. The attack sparked fears across Europe of revived Russian imperial ambitions.

18 NATO members expected to hit target in 2024 – Only 11 of the 30 NATO member countries met the 2% of GDP spending targets in 2023, but 18 NATO members are expected to hit targets in 2024 according to NATO Secretary-General Jens Stoltenberg. New member Finland hit 2.5% of GDP target in its first year of membership, with the expectation that Sweden will do the same in 2024 once formally approved as a new NATO member.  In 2023, the United States still accounted for 68% of NATO’s defence spend representing $860 billion USD of the total $1.3 trillion in spend. NATO Secretary-General Stoltenberg expects the number of states meeting the 2% threshold will rise rapidly amid increased aggression around the world.

Germany says defence spending could increase to 3.5% of GDP – Germany has vowed to ramp up its investment in defence to reverse years of neglect.  German Defence Minister Boris Pistorius describes the 2% of GDP target is only a “starting point” as European nations need more capable forces as they expand their engagement in the world.  Germany had been under fire from NATO for not spending more on its military, but Russia’s invasion of Ukraine has been a “historical turning point” for Germany and its NATO allies.

McKinsey report expects half of NATO countries will hit 2% target in 2025 – New initiatives continue to progress to increase cooperation on developing military capabilities in Europe, such as the Future Combat Air System and the Main Ground Combat System, while more than 15 European countries have joined forces as part of the European Sky Shield Initiative to develop a multilayer air and missile defence system.  A fragmented landscape of in-service weapon systems in Europe adds complexity to the underlying spending challenge. Further, acquisition decisions are made by individual nations sourcing from a mix of domestic, regional, and global suppliers, with additional specifications to meet local requirements. This fragmented approach has resulted in 2 to 3 times as many European suppliers competing at the platform level – aircraft, tanks, and ships – as opposed to in the U.S. Europe faces challenges of how to achieve industrial scale to lower costs, increase production rates, and create a more resilient industrial supply chain.

EU plans to create defence-industrial complex ready for war – The EU has laid out a 27-page plan in response to the war in Ukraine and the need to restart arms and ammunition production. The main goals include streamlining procurement, making it easier to sell arms to other countries, providing more funding for joint procurement, and increased production levels, that will remain high. These measures represent a paradigm shift from emergency response to defence readiness.

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Macro Outlook

Spurred by the Russia-Ukraine war and global aggressions in regions like the Middle East, Europe has a new resolve to revitalize its defence capabilities, seeing a paradigm shift from emergency response to defence readiness. But challenges remain. Its country-centric approach has resulted in a fragmented industrial platform that is difficult to scale to lower costs and increase production efficiency.  As a result, the EU is developing plans to restart arms and ammunition production, along with goals to streamline procurement, make it easier to sell arms to other NATO member countries, provide funding for joint procurement, and maintain production levels and supplies.  And NATO spending commitments are starting to be met.  While only 11 member nations met the 2% of GDP target in 2023, 18 countries are on track to do so in 2024, with projections for more than 50% compliance by 2025.  And new countries like Finland and Sweden are being added to the spending mix and hitting their spending targets on day one.