Australia has three advantages for our defence: our geography, our friends, and our military edge.
But the last of these three is – to put it bluntly – at risk. To regain and preserve that edge, Australia needs far deeper engagement from the finance sector in our defence ecosystem.
Comprised of the big banks, superannuation funds, private wealth managers and venture funds, this is an interest group that Australia’s defence establishment has little experience engaging with. But it will have to, if Australia is to fund its national security needs.
Convincing private capital that Australia’s defence is an asset class worth investing in is a minefield. For starters, private equity is seeking profitability and scale and Australia’s relatively small defence industry does not look attractive.
There’s also uncertainty for business, with changes in government and frequent changes to the Defence department’s procurement requirements – just think of the rollercoaster we’ve been through with Australia’s future submarines. Then, for socially conscious VC’s especially, another concern is the ESG risk and not wanting to finance 'things that go bang.'
Australia has three advantages for our defence: our geography, our friends, and our military edge. But the last of these three is – to put it bluntly – at risk.
Put simply, government must lower the risk and increase the payoff for private capital.
Defence has an expansive funding profile – not only military capability but bricks and mortar infrastructure. With the requirement to upgrade defence bases around the nation, these are safe investments for banks and super and will provide reliable returns.
Beyond infrastructure, research and development of dual-use technologies presents a separate investment opportunity with a different risk-reward profile. Defence needs to attract the right type of investors for the full range of opportunities and risks across defence assets.
Bridging the financing gap
The need to co-opt private financiers isn’t just a challenge for Australia; it’s also a challenge facing the world’s largest defence spender, the United States.
The United States spends 16 times the amount on its defence as Australia: more than $US800 billion ($1.2 trillion) compared with $US50 billion. Despite the size of the US defence budget, America is still turning to private capital to fund its defence research and technology development.
Developing future technologies like those under AUKUS “Pillar Two” – a tripartite partnership covering dual-use or military applications of tech such as hypersonics, quantum, artificial intelligence, and electronic warfare – can act like black holes for money.
Despite the size of the US defence budget, America is still turning to private capital to fund its defence research and technology development.
The United States has spent $US8 billion on hypersonics alone over the last five years and is seeking a further $US13 billion for development. If the United States fails to make advancements in these fields, it risks falling behind competitors like China.
To bridge the financing gap, the United States has established the Office of Strategic Capital (OSC) within the Pentagon – a big step. The OSC is focused on “crowding in” private finance to develop critical technologies with defence applications. US private capital leads the world for investment in new companies and product development, and the Pentagon is seeking to tap into this vast reservoir.
Rather than provide acquisition-based grants and contracts, the OSC uses low-cost, government-backed loans and loan guarantees, combined with private capital. Government co-investment lowers the risk for private funders, facilitating investment in higher-risk technologies. This has potential to bridge the gap in emerging technology financing and represents an innovation in the way the US is both driving and resourcing its military capabilities.
Australia has no OSC equivalent, but it does have a large national network of funds that the defence establishment could draw from to provide an incentive to public-private partnerships.
The money is there
The $15 billion National Reconstruction Fund has seven priority funding areas, two of which are defence capability and enabling capabilities. The fund’s capacity to issue loans, equity investment, and guarantees could provide Defence with the type of finance tools it needs to co-invest with private capital.
Additional co-investment could come from the $3.8 billion Defence Export Facility, $3.4 billion Advanced Strategic Capabilities Accelerator, or $1.6 billion Australian Economic Accelerator. The money is there; it just needs to be harnessed.
There are also positive signs Australia’s banking sector is recognising the defence investment opportunity.
Earlier this year, Export Finance Australia (EFA) – the government’s export credit agency – and Westpac struck a first-of-kind partnership to help Australian defence companies upscale. The initiative helps smooth the capital flow for defence SMEs, assisting them to access finance for build components, capital expenditure and bridging finance. If EFA and Westpac can demonstrate financial returns, the other major banks – ANZ, Commonwealth, and NAB – could strike similar deals with government.
There are also positive signs Australia’s banking sector is recognising the defence investment opportunity.
Crowding in the banks would be a game-changer for financing Australia’s defence, especially if it promotes broader market confidence in the sector.
In a time of AUKUS delivery and post the Defence Strategic Review, the moment has arrived for Defence to do business differently. Rather than government relying too heavily on strategic statements to communicate its demand signal to industry, it must be proactive. Defence offering to co-invest and adopting private sector financing tools, as the US has done, could help.