The changing investment landscape in European Defense and the role of private and public capital
The European Union (EU) is witnessing a significant transformation in its defense investment strategy, driven by geopolitical dynamics and a renewed emphasis on strategic autonomy. Initiatives such as the European Defence Fund (EDF), with a budget of €8 billion for the 2021-2027 period, and the launch of the €175 million Defence Equity Facility (DEF) in January 2024, underscore the EU’s commitment to enhancing its defense capabilities. These developments have opened avenues for private capital to engage in defense-related sectors, including cybersecurity, aerospace, and defense technologies. However, structuring investment funds targeting defense assets remains complex due to regulatory considerations, investor scrutiny, and alignment with EU policy objectives.
Luxembourg, as the leading European jurisdiction for cross-border investment funds, offers a unique ecosystem for structuring defense-focused investment vehicles that can attract both EU and international institutional capital.
Certain initiatives already have recognized Luxembourg’s potential as a strategic location for defense investments. For example, the NATO Innovation Fund, which is a Luxembourg SIF (as explained below), is a defense fund that has pledged €1 billion to Europe’s defense innovators, targeting start-ups and other capital funds that develop emerging disruptive technologies with both civilian and defense applications. Luxembourg has contributed €28 million to this initiative.
The European Investment Fund (EIF) is currently taking a proactive role in bolstering Europe's defense sector by investing in venture capital and private equity funds that target innovative defense technologies through the InvestEU programme. A notable example is the EIF's €40 million investment in Keen Venture Partners’ European Defence and Security Tech Fund, marking its first direct commitment to a dedicated European defense fund. This fund focuses on early-stage companies developing solutions in areas such as cyber defense, autonomous systems, and space technologies. These investments are part of the Defence Equity Facility we referred above.
Finally, on the private sector side, top global and European asset managers are accelerating their deployment of capital into the defense sector through a range of tailored investment structures designed to align with evolving European defense priorities. The renewed focus on strategic autonomy, driven by geopolitical tensions and increased EU and NATO defense spending, has paved the way for asset managers to offer institutional and retail investors targeted exposure to defense and dual-use technologies.
BlackRock, BNP Paribas, and other major players have recently launched defense-focused Exchange Traded Funds—vehicles traditionally used for liquidity and index exposure—to capture investor interest in listed European defense contractors and technology firms. These ETFs are designed to be UCITS-compliant, offering high transparency and daily liquidity, making them suitable for retail and institutional portfolios. According to Reuters, investors poured over $2.7 billion into such European defense ETFs in the first five months of 2025 alone, more than doubling the inflows recorded during all of 2024.
In parallel, private equity and venture capital firms are increasing their presence through closed-ended fund structures. These vehicles offer the flexibility to invest in high-risk, high-return projects including military AI, space and drone technologies, and cybersecurity firms. As reported by PE Insights, European-focused defense funds are leveraging these alternative structures to enable long-term, illiquid investments that align with the development cycle of emerging defense technologies. Fund managers are also exploring co-investment arrangements with EU institutions (such as through the EIF's Defence Equity Facility), amplifying the capital base and strategic impact of their funds.
Tailored Legal Structures for Defense Investment Funds in Luxembourg
Luxembourg’s flexible regulatory framework provides multiple fund structures that can accommodate different investor profiles, risk-return strategies, and regulatory considerations. Asset managers looking to structure investment vehicles in the defense sector have a range of options under Luxembourg law, each offering distinct advantages.
1. Reserved Alternative Investment Fund (RAIF) – Speed and Flexibility
The RAIF is particularly well-suited for defense investments, offering:
No prior regulatory approval from the CSSF, ensuring fast market entry.
Supervision through an alternative investment fund manager, ensuring compliance with Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010 Text with EEA (the “AIFMD”).
Unrestricted eligible assets with risk diversification rules. Broad investment flexibility, including private equity, infrastructure, and direct asset ownership in defense technology companies.
Suitable for institutional and professional investors seeking rapid deployment of capital into defense projects, including EDF-backed initiatives.
For those RAIFs subject to the SIF tax regime, they are not subject to net wealth tax, corporate income tax and withholding tax. It is liable to annual subscription tax of 0.01% on its net asset value subject to certain exemptions. For those RAIFs subject to the SICAR tax regime, they are not subject to withholding tax and annual subscription tax. It is fully taxable to income tax at normal rate (corporate income tax and municipal business tax) but exempt from income derived from transferable securities and income from cash held for a maximum period of one year prior to its investment in risk capital. Finally, it is subject to annual minimum net wealth tax rate if structured as a corporate vehicle (S.A., S.à r.l. or SCA) which is less than EUR 5,000.
Luxembourg Market Trend: RAIFs have become a preferred choice for alternative asset managers since their introduction in 2016, particularly in sectors requiring agile fund launches.
2. Specialised Investment Fund (SIF) – Institutional-Grade Defense Investments
The SIF is a strong alternative for asset managers seeking a regulated structure with access to a diverse range of institutional investors.
Requires Commission de Surveillance du Secteur Financier (CSSF) authorization, ensuring additional investor protection.
Unrestricted eligible assets with risk diversification rules, making it ideal for multi-asset defense investment strategies (e.g., cybersecurity, military AI, and space technologies).
Not subject to withholding tax, corporate income tax and municipal business tax. It is liable to annual subscription tax of 0.01% on its net asset value subject to certain exemptions.
Luxembourg Market Trend: The SIF remains a choice for fund managers managing EU public funds like the NATO Innovation Fund. These types of structures also partner with other private co-investors (being regulated funds set up by top private asset managers) to finance and invest in EU defense innovators, start-ups and other capital funds that are developing emerging disruptive technologies with both civilian and defense applications.
3. Luxembourg Limited Partnerships (SCS/SCSp) – Private Equity-Like Structures for Defense Funds
Luxembourg’s special limited partnership (SCSp) and common limited partnership (SCS) are particularly suited for private equity-style investments in defense and security.
Contractual flexibility, allowing for tailored governance and investor rights.
Unrestricted eligible assets and no risk-spreading requirements, making them ideal for concentrated investments in high-growth defense startups or specific projects (e.g., military AI, space, and drone technology).
Can be structured as an alternative investment fund under AIFMD for broader investor access.
Not subject to withholding tax, wealth tax, annual subscription tax, corporate income tax and municipal business tax. For the exemption of this municipal business tax to apply, the structuring of the GP’s partnership interest in the SCSp/SCS must ensure that it does not exceed 5%, to avoid the deemed commercial characterisation of the SCSp/SCS, which would otherwise trigger such tax.
Luxembourg Market Trend: The SCSp AIF has the potential to gain traction among venture capital and private equity funds investing in sensitive industries such as defense tech and cybersecurity.
4. Société d’Investissement en Capital à Risque (SICAR) – Targeting High-Risk Defense Innovation
For higher-risk, private equity-style investments in defense and security, the SICAR remains an attractive vehicle.
Restricted to investments in securities representing risk capital.
No risk diversification requirement, allowing focused investments in single defense-related projects.
Specifically designed for private equity and venture capital investments.
Corporate or partnership form, offering flexibility in structuring carried interest and investor rights.
Not subject to withholding tax and annual subscription tax. It is fully taxable to income tax at normal rate (corporate income tax and municipal business tax) but exempt from income derived from transferable securities and income from cash held for a maximum period of one year prior to its investment in risk capital. Finally, it is subject to annual minimum net wealth tax rate if structured as a corporate vehicle (S.A., S.à r.l. or SCA) which is less than EUR 5,000.
Luxembourg Market Trend: SICARs have the potential to be increasingly used for high-risk defense tech investments.
Legal and Regulatory Challenges in Adapting Fund Investment Policies to Defense Assets in Luxembourg and the EU
The renewed interest in defense as a strategic asset class presents a complex legal and regulatory challenge across the European investment management landscape, particularly in jurisdictions like Luxembourg that serve as key domiciles for cross-border investment funds. The evolution of EU-wide defense priorities — including the EDF, and NATO-aligned spending commitments — has prompted a growing appetite among institutional and private investors to participate in defense-related opportunities. However, existing fund regulations and legal frameworks impose notable constraints on the adaptation of fund policies to accommodate defense investments.
1. Luxembourg Product Law Constraints
In Luxembourg, investment funds are structured under various product regimes — including UCITS, Part II funds, SIFs, RAIFs, and SICARs — each with varying levels of regulatory scrutiny and permissible investment strategies.
UCITS Limitations: Undertakings for Collective Investment in Transferable Securities (UCITS) are constrained by strict diversification and eligible asset rules under Directive 2009/65/EC. Investments in defense companies are not prohibited per se, but many such companies may not meet the liquidity and eligibility criteria for transferable securities. Moreover, certain sub-sectors (e.g., arms manufacturing or dual-use technologies with limited civilian applications) may raise ESG compliance and reputational risks with retail-focused investors and distribution platforms.
SIF and RAIF Regimes: While SIFs and RAIFs offer greater flexibility in terms of asset allocation, they must comply with the risk-spreading requirements and be managed by an authorised AIFM under the AIFMD framework other than certain SIFs organized under the Law of 13 February 2007. Investment policies targeting defense assets require careful drafting to ensure compliance with the risk diversification rules, particularly when investing in non-listed or strategic industrial assets. Defense assets may also challenge portfolio diversification limits, especially when exposure is concentrated in a few large contractors.
SICAR Regime: The SICAR regime as detailed above may be more suitable for defense-related private equity strategies, as it is specifically designed for risk capital investments. However, qualifying defense investments must satisfy the criteria of "risk capital," and the SICAR structures in certain cases remains subject to AIFMD rules and may face investor perception issues due to its specific sectoral focus.
2. EU-Level Restrictions and ESG Frameworks
At the EU level, the intersection between defense investing and the ESG agenda represents a central legal and reputational challenge. Several key EU regulations and initiatives affect defense investments:
SFDR and Taxonomy Regulation: The Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy for Sustainable Activities pose significant hurdles for fund managers investing in defense. Neither the SFDR nor the Taxonomy Regulation currently qualifies defense activities — particularly those involving arms production — as "environmentally sustainable." Furthermore, the social taxonomy discussions under the EU Commission have explicitly considered the exclusion of weapons-related activities from sustainable investment definitions. As a result, funds classified under Article 8 or Article 9 SFDR are disincentivized or outright restricted from investing in defense assets, leading to a structural misalignment between ESG commitments and defense investment strategies.
Exclusion Policies and Investor Mandates: Institutional investors, particularly pension funds and insurance companies, often operate under internal exclusion lists or fiduciary mandates that prevent investments in weapons, military goods, or dual-use technologies. These restrictions are often codified in national laws or internal risk management policies (e.g., the Norwegian Government Pension Fund or certain Dutch institutional investors), limiting the universe of LPs willing to allocate capital to defense-focused vehicles.
Public Procurement and Dual-Use Export Controls: Funds seeking to invest directly in defense contractors or infrastructure may also encounter regulatory obstacles relating to public procurement law, EU dual-use regulation (Regulation (EU) 2021/821), and national security screening mechanisms (e.g., Regulation (EU) 2019/452 on foreign direct investment screening). These add legal complexity, particularly for non-EU investors or funds with cross-border strategies.
3. Operational and Licensing Implications for AIFMs of Alternative Investment Funds and Management Companies (ManCos) of UCITS.
Luxembourg-authorised AIFMs and ManCos managing funds with exposure to defense assets must navigate operational and compliance risks:
KYC/AML Compliance: Investments in defense technologies or companies involved in geopolitically sensitive operations may trigger enhanced due diligence under AML/CFT rules. AIFMs and ManCos are expected to ensure that defense investments do not indirectly involve sanctioned entities, conflict minerals, or dual-use exports in breach of EU restrictive measures.
CSSF and Regulatory Supervision: While the CSSF does not explicitly prohibit investments in defense, fund managers must be prepared to explain the rationale and risk management approach to such exposures. In practice, AIFMs and ManCos are expected to provide clear disclosures in the PPM regarding investment strategy, risk factors, ESG compliance, and conflicts of interest — especially for defense-linked sectors.
Practical Challenges in Investor Communication and Fundraising: Even where legally permissible, defense investments remain sensitive from a marketing and investor relations standpoint. Asset Managers must carefully craft offering documents to mitigate reputational concerns and provide transparency regarding the ethical boundaries of defense-related investments. Marketing strategies in jurisdictions with restrictive views on arms investments require tailored disclosure and careful alignment with investor expectations.
Positioning Luxembourg as a Defense Investment Hub
As the EU mobilizes significant funding for defense initiatives, Luxembourg’s legal and regulatory framework offers asset managers a competitive edge although still with some EU regulatory clarifications needed in the future. The Grand Duchy’s ability to structure investment vehicles that align with EU strategic autonomy goals while remaining attractive to international investors makes it a key jurisdiction for launching in the near future defense-focused funds.
With the right structuring—whether through (i) RAIFs and SCSPs/SCSs for rapid market entry, or (ii) the regulated SIFs, UCITS and SICARs for institutional-grade strategies—Luxembourg remains the go-to destination for asset managers looking to capitalize on Europe’s growing defense investment landscape in the coming years.
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