Podcast Summary: "How AI Is Disrupting Defense"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: How AI Is Disrupting Defense
• Release Date: July 8, 2025
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

Introduction

In the July 8, 2025 episode of Thoughts on the Market, Ross Law from Morgan Stanley's European Aerospace and Defence Team and Arushi Aggarwal from the European Sustainability Research Team delve into the transformative role of Artificial Intelligence (AI) in the defense sector. The discussion is set against the backdrop of Europe's recent decision to increase defense spending, highlighting the intersection of sustainable investing, technological innovation, and national security.

Rising Defense Spending and AI Integration

Ross Law opens the conversation by addressing the significant policy shift at the recent NATO summit, where member countries agreed to elevate their defense spending from 2% to 3.5% of GDP. This increase is projected to inject an additional $200 billion annually, primarily directed towards equipment rather than personnel.

Ross Law (00:11): “At the recent NATO summit, member countries decided to boost their core defence spending target from 2% to 3.5% of GDP. This big jump is sure to spark a wave of innovation in defense, particularly in AI and military technology.”

Arushi Aggarwal elaborates on Europe's strategic emphasis on rearmament, emphasizing AI's pivotal role in revolutionizing defense mechanisms—from unmanned systems and cyber defense to simulation training and precision targeting.

Evolution of Sustainability in Defense

Arushi Aggarwal discusses the evolving concept of sustainability to encompass national security and defense, particularly in the European context. Historically, defense companies were often excluded from sustainability funds due to ethical concerns surrounding conventional and nuclear weapons. However, geopolitical tensions have shifted perspectives, prompting asset managers to reconsider these exclusions.

Arushi Aggarwal (01:21): “Geopolitical tensions have really pushed national security much higher on the sustainability agenda. We're seeing a structural shift in sentiment towards defence investments.”

She notes the emergence of thematic funds focused on security and resilience, despite the lack of standardized methodologies for assessing weapon-related exposures and sector-specific ESG risks. Investors are now questioning whether rapid technological integration can facilitate a more forward-looking and risk-aware approach to investing in national security.

AI's Role in European Rearmament Strategy

Ross highlights AI's centrality in the EU's €800 billion rearmament plan. The integration of advanced technologies like AI, quantum computing, biotech, robotics, and hypersonics is deemed essential not only for long-term economic growth but also for maintaining military superiority.

Ross Law (02:31): “Our estimates suggest this could mean an additional $200 billion per year in additional spend with a focus on equipment over personnel, at least for the time being.”

He references the Paris Air Show, where nine key AI applications reshaping defense were identified, with cybersecurity and unmanned systems leading in preparedness and investment.

Ross Law (04:01): “We've identified nine key AI applications reshaping defence. And our application readiness radar shows that cybersecurity followed by unmanned systems exhibit the highest level of preparedness from a public and private investment perspective.”

Arushi adds that the EU's plan anticipates NATO's military spending on AI could potentially double to $112 billion by 2030, with a bullish scenario projecting a sixfold increase to $306 billion.

Arushi Aggarwal (02:55): “In our base case, we estimate that total NATO military spend into AI applications will potentially more than double to $112 billion by 2030. This is at a 4% AI investment allocation rate.”

AI Applications Leading Defense Innovations

During the Paris Air Show, significant advancements in AI-driven defense technologies were showcased. Cybersecurity remains a top priority due to the rise in cyber attacks and disinformation campaigns, with AI being utilized for both defensive and offensive measures. Unmanned systems, particularly drones, are transforming battlefields, as evidenced by their prominent role in conflicts like Ukraine.

Ross identifies other burgeoning areas such as simulation and war gaming, which are expected to grow in demand alongside increased defense spending.

Ross Law (04:59): “Cybersecurity is a major priority due to increased proliferation of cyber attacks and disinformation campaigns. Unmanned systems are also really taking off, mainly driven by the rise in drone warfare that's reshaping the battlefield.”

European Defense Companies and AI Readiness

European aerospace and defense companies are making significant strides in AI readiness. They exhibit higher pricing power compared to their U.S. counterparts and demonstrate robust capabilities as both enablers and adopters of AI. These companies are forging partnerships with government research institutions, leading software firms, and private sector players to accelerate AI integration.

Ross Law (05:05): “European A and D companies have higher pricing power relative to their US counterparts. And a higher percentage are both enablers and adopters of AI.”

Additionally, the dual-use nature of AI technologies allows for civilian applications, such as geospatial capabilities for wildfire management and maritime surveillance, broadening the impact and utility of defense-oriented AI innovations.

Ross Law (05:51): “Various companies in our coverage are using their AI capabilities for civilian applications across multiple domains.”

Regulatory Developments in Europe

Arushi Aggarwal outlines the European Commission's efforts to streamline defense investments through regulatory reforms. Key initiatives include:

• Defense Omnibus Simplification Proposal: Aims to expedite defense investments within the EU.
• Guidance on Sustainable Finance Framework: Integrates defense investment within sustainability criteria.
• Sustainability Reporting Directive Amendments: Tailors reporting obligations to better reflect defense industry needs.
• Sustainable Fund Reform: Clarifies the role of defense investments within sustainable finance without outright prohibitions.

At the European Security Summit, a roadmap focusing on modernizing European defense with an emphasis on AI and quantum technologies was announced, set to be published in Autumn.

Arushi Aggarwal (06:22): “The European Commission is working on a defence omnibus simplification proposal aimed at speeding up defence investments in the EU.”

These regulatory changes are expected to act as catalysts, providing clear demand signals and trend directions for the defense sector, although individual investor positioning remains gradual.

Navigating Ethical Considerations in AI-Driven Defense

The discussion concludes with addressing the ethical challenges of integrating AI into defense. Arushi Aggarwal emphasizes a dual approach to AI risk management:

1. Technical Challenges: Implementing safeguards within AI models, such as training systems to refuse harmful requests.
2. Coordination Challenges: Fostering international dialogue and cooperation to prevent AI misuse and ensure non-proliferation.

Arushi Aggarwal (07:51): “AI risk management requires the ability to tackle two types of challenges... The key is balance. On the one hand we have to recognize the legitimate security needs that defence technologies address and on the other hand there's the need to ensure appropriate safeguards and oversight.”

From an investor standpoint, closer corporate engagement is crucial. This involves ensuring transparency in algorithms, decision-making processes, and data sets used to train AI models.

Conclusion

The episode underscores the transformative impact of AI on the defense sector, particularly within Europe’s strategic rearmament efforts. As defense spending ramps up, AI's role becomes increasingly pivotal, driving innovation while also raising critical ethical and regulatory considerations. Investors, policymakers, and technologists must navigate this evolving landscape with a balanced approach, ensuring that technological advancements contribute to national security without compromising ethical standards.

Notable Quotes:

• Ross Law (00:11): “At the recent NATO summit, member countries decided to boost their core defence spending target from 2% to 3.5% of GDP. This big jump is sure to spark a wave of innovation in defense, particularly in AI and military technology.”

• Arushi Aggarwal (01:21): “Geopolitical tensions have really pushed national security much higher on the sustainability agenda. We're seeing a structural shift in sentiment towards defence investments.”

• Ross Law (04:01): “We've identified nine key AI applications reshaping defence. And our application readiness radar shows that cybersecurity followed by unmanned systems exhibit the highest level of preparedness from a public and private investment perspective.”

• Arushi Aggarwal (07:51): “AI risk management requires the ability to tackle two types of challenges... The key is balance. On the one hand we have to recognize the legitimate security needs that defence technologies address and on the other hand there's the need to ensure appropriate safeguards and oversight.”

This comprehensive summary encapsulates the key discussions from the episode, providing insightful perspectives on AI's disruptive role in defense, the evolving landscape of sustainable investing, regulatory developments, and the ethical considerations that stakeholders must navigate.