Is it possible to discuss defence finance without immediately causing unease, given memories of arms scandals and debates over the ethics of investment? And, more specifically, can a small country like Luxembourg turn this sensitive issue into a new cornerstone of its economic model?

This is not a theoretical question. Under pressure from the war on its borders, Europe is embarking on a sustained path of increased defence spending. Governments are making announcements, the industry is investing, and budgets are rising. But the money does not organise itself. Financial frameworks, investment vehicles and clear rules of the game for institutional investors are needed.

However, Luxembourg has already set a precedent that many have yet to notice: a Defence Bond Framework, the first of its kind in Europe, which provides a framework for the financing of defence spending by drawing on the sophistication of its financial centre.

In other words, defence finance is not just on its way to Luxembourg. It is already here. The question is whether the country will choose to turn it into a strategic asset or allow it to develop on the fringes, without a clear vision or robust governance.

When defence becomes a “dual-use” issue

For a long time, any mention of defence automatically brought to mind tanks, aircraft and frigates. Today, the landscape has changed. An increasing proportion of defence spending is directed towards dual-use assets – for both civilian and military purposes – in four key areas: cybersecurity, space, data and high-performance computing.

Luxembourg has a major advantage, provided it seizes it: it is already well positioned in these four areas even before defence became a key issue. MeluXina, the national supercomputer, places the country among Europe’s leaders in high-performance computing. The data centres interconnected via Lu-cix form a sovereign digital backbone. Luxembourg’s space ecosystem provides services in satellite observation, connectivity and data analysis. Finally, the financial sector already operates under the Dora and NIS2 frameworks, which have made cybersecurity a mandatory discipline and practice.

Add to this a €40m fund from the SNCI dedicated to dual-use projects and a Defence Bond Framework that is already up and running. The pieces are therefore in place. Defence finance, in this context, is not a concept imported from elsewhere: it builds on existing trends.

In this respect, the idea of a Luxembourg Defence Security Innovation Fund is by no means out of the ordinary. It would serve as a vehicle enabling institutional investors – pension funds, insurers and long-term investors – to finance European dual-use projects within a clear, well-defined and properly governed framework.

Why Luxembourg is well placed… and why this will become apparent

Why couldn’t this role be played just as well by Paris, Berlin or Amsterdam? On paper, there is nothing to prevent it. In reality, however, Luxembourg has three specific advantages.

Key strength: extensive experience in managing complex transactions. Sovereign wealth funds, private equity, multi-jurisdictional structures, ESG: the financial centre has built its reputation on its ability to handle sophisticated transactions whilst maintaining high standards of compliance.

Second strength: a combination of regulatory oversight (CSSF, BCL), standards (Dora, NIS2) and tax-neutral vehicles that few financial centres can replicate exactly. This makes it possible to design defensive financial instruments that are not grey areas, but transparent entities: we know who is investing, in what, under what conditions, and subject to what safeguards.

Third strength: a financial engineering culture with a European focus. Whilst some major countries view defence primarily through the prism of national policy, Luxembourg can position itself as a platform for financing European projects – particularly in the dual-use sector – without being tempted to bring everything back home.

Ultimately, this paves the way for a clear strategic positioning: to become a pan-European hub for defence finance, in a similar way to how the country has established itself as a major platform for asset management and sustainable finance. The figures involved are not out of reach: capturing 1 to 2% of European defence-related flows, through agile and well-regulated arrangements, could constitute a very sound strategy for the Grand Duchy.

The potential blind spot: a poorly governed “financial PPP”

All this would be a fine story were it not for the fact that defence funding often has a well-known Achilles’ heel: governance. There are countless examples elsewhere in Europe of defence-related arms programmes or public-private partnerships that have been plagued by cost overruns, delays, unfair contract terms and a lack of budgetary transparency.

When applied to defence finance, this is a highly critical issue: what happens if a poorly designed financial PPP shifts the bulk of the risk onto the state, whilst allowing the private sector to pocket the returns? What happens if additional costs are concealed in successive amendments or if the information provided to investors remains incomplete?

In a country whose reputation rests precisely on the strength of its institutional structures, such a lapse would not merely be an accounting issue. It would cause lasting damage to Luxembourg’s credibility as a Nato partner and as a reliable hub for defence finance.

This is where another distinctive feature of Luxembourg comes into play: the culture of governance that has developed within the boards of directors of funds, banks and investment vehicles. The country has a pool of external directors who are accustomed to reading complex business plans, challenging financial assumptions and spotting an excessive guarantee clause buried within a 300-page contract.

When applied to defence finance, these profiles are not merely a “nice-to-have”. They form the immune system of financial structures: they are the ones who can say no to an unbalanced transfer of risk, misaligned remuneration or an unjustifiable lack of transparency in a sector that is inherently sensitive.

A strategic choice, not a technical niche

It might be tempting to view defence finance as a technical niche best left to specialist lawyers and financial engineers. That would be a mistake. Behind the acronyms and structuring diagrams lies a strategic choice for all stakeholders and for Luxembourg.

Option one: view defence either as a cost centre to be funded as discreetly as possible, or as a lever for technological sovereignty and industrialisation, with finance serving as its acknowledged driving force.

Option two: allow defence finance to develop in fits and starts, as opportunities arise, or make it a clear pillar of a broader policy encompassing cyber, space, data and human capital.

Third option: treat governance either as a legal add-on tacked on at the end of the process, or as the starting point for any discussion, recognising that defence funding is only as good as the governance that underpins it.

For our small country, these trade-offs may prove more significant in the long term than the size of the budget. Luxembourg will never carry much weight in terms of the volume of its military spending. However, it can make its mark through the ingenuity of its financial structures, the quality of its public-private partnerships and the high standards of its boards of directors.

The window of opportunity

 Europe is rearming, investors are seeking clear exposure, and manufacturers need stable and reliable partners. Against this backdrop, Luxembourg finds itself, as so often, in a unique position from which it must learn to capitalise: too small to wield raw power, but sophisticated enough to channel some of the financial flows that will accompany Europe’s rearmament.

It remains to be seen whether the country will fully embrace this role. Defence funding can be either an awkward subject dealt with behind closed doors, or a new strategic frontier where the Grand Duchy demonstrates, once again, that it knows how to turn a constraint into an opportunity.

The answer will not be found in any single fund or instrument. It will lie in Luxembourg’s ability to bring together, under a single umbrella, three elements that are already part of its DNA: financial structuring, European ambition and a culture of rigorous governance.

*François Dorland, an external director and Franco-Luxembourgish executive, has for many years advised organisations where public, industrial and private capital converge, with a particular focus on the quality of governance in long-term arrangements. A graduate of HEC Paris in family business governance and a multiple CSSF-accredited director, he has observed at close quarters how certain management weaknesses can erode the value of partnerships that are otherwise strategic.