[Special Feature: Can Investment Change Society?] Nobuyuki Ogata: Tracing the Philosophy of ESG Investment through Western History

Currently, ESG investment is expanding rapidly in Japan. Although ESG investment only began in earnest in Japan after 2015, as of the end of 2019, the scale of Japan's ESG investment market reached 2.874 trillion USD, making it the third largest in the world*1, despite a significant gap compared to the 17.081 trillion USD of the US market and the 12.017 trillion USD of the European market. Before 2015, only a very small number of institutional investors were engaged in ESG investment. The reason the Japanese ESG investment market developed so rapidly in a short period lies in the policies of the Japanese government.

On the other hand, the ESG investment markets in Europe and the US have a history of over 100 years, and their origins can be traced back over 400 years. Furthermore, equity investments by British and American Christian churches (hereafter, "churches") based on Christian ethics have led the way in ethical investment and Socially Responsible Investment (SRI), the predecessors of ESG investment. The theologian Paul Tillich presented the proposition that "Religion is the substance of culture, culture is the form of religion"*2. Additionally, the economist Alfred Marshall stated in the introductory chapter of his book "Principles of Economics" (1920 edition) that "the world's history has been shaped by religion and economics... at times, religious motives are more intense than economic ones." Based on these claims, it is considered that an investment philosophy based on Christian ethics exists at the root of ESG investment in the West.

The author believes that by tracing the history of ESG investment in the West, suggestions can be obtained for considering the challenges and prospects of ESG investment in Japan. Furthermore, I believe it will serve as a guidepost for ESG investors in a world where divisions are deepening due to Russia's invasion of Ukraine.

The origins of ESG investment are said to be the norm of "renunciation of war, violence, and weapons" shown by George Fox, the founder of the Quakers, a sect of Protestant Christianity in 17th-century England, or the 1760 sermon collection "The Use of Money" by John Wesley, the founder of Methodism in 18th-century England*3. "The Use of Money" is quoted by Max Weber in "The Protestant Ethic and the Spirit of Capitalism." Furthermore, it continues to have a strong influence on Western society today, as seen when the then British Minister for Pensions quoted it in a speech during the 2000 amendment of the UK Pensions Act, which triggered the expansion of the European SRI market.

In "The Use of Money," Wesley presented three principles: "Gain all you can, Save all you can, and Give all you can." While Wesley warned against an obsession with money, he taught that money is a tool for doing all kinds of good. He also preached to work diligently and earn as much as possible without wasting time, to save as much as possible while avoiding luxury, and to give the remaining money to the poor as much as possible, except for what is necessary for oneself and one's family. This is a concept based on the biblical principle that God created humans not as owners of property, but as stewards.

Furthermore, as a major premise for acquiring money, Wesley warned that one must not earn by harming the spirit and body of one's neighbor. Specifically, he warned against acquiring money through gambling and alcohol. Wesley's "The Use of Money" and the Quaker norm of "renunciation of war, violence, and weapons" became an investment method called negative screening, which excludes stocks of specific companies that go against Christian ethics from investment targets, and this has been passed down to current ESG investment.

In the 20th century, ethical investment based on Christian ethics began to be practiced in Western churches. To the best of the author's knowledge, the pioneer was Wespath Investment Management (hereafter, Wespath), established in 1908 by the Methodist Episcopal Church (now the United Methodist Church) in the US as an institution to manage and operate pensions. Wespath began asset management by inheriting the ethics written in the Bible and Wesley's faith*4.

In 1928, the world's first publicly offered investment trust, "The Pioneer Fund," was established in the US, excluding stocks of companies related to alcohol and gambling. At that time, Prohibition was in effect in the US, and gambling was also prohibited nationwide. Prohibition inherited the strict Puritan faith. Puritan thought had a great influence from before the founding of the US until that time. However, the fund's scale was small and its influence was limited, partly because the Great Depression occurred the following year. Until the mid-20th century, ethical investment was centered on churches*5.

In the 1960s, social movements and political activities such as civil rights, women's rights, consumer movements, environmental protection, and anti-Vietnam War protests were actively developed in the US. To demand social responsibility from companies, social activists began to make shareholder proposals at general meetings of shareholders. Such movements have been passed down to engagement and the exercise of voting rights in SRI and ESG investment. In 1971, two ministers of the United Methodist Church played an important role in establishing a publicly offered investment trust (SRI fund), The Pax World Fund, which excluded the military industry from investment targets*6. In this way, in addition to ethical investment by churches, SRI funds purchased by individual investors appeared in the US.

In the 1980s, apartheid in the Republic of South Africa (hereafter, South Africa) became a target of international criticism, and the UN and Western countries led the implementation of economic sanctions against South Africa. Meanwhile, SRI funds excluding South Africa-related companies increased rapidly, and divestment—selling stocks of companies operating in South Africa—by churches and universities also became active. Due to such SRI pressure and economic sanctions, British and American financial institutions, which were South Africa's largest funders, withdrew. As a result, South Africa declared default in 1985. Such investment actions in South Africa increased the presence of SRI in Western financial markets*7.

In the 1990s, as governments in European countries promoted SRI as a policy, institutional investors entered the SRI market. The amendment to the Pensions Act implemented in the UK in 2000 had a particularly large impact on the SRI market. The law required pension funds to consider SRI in their investment policies and the exercise of voting rights. As a result, the center of SRI in the UK shifted from churches and charitable organizations to insurance companies and pension funds following the amendment. After the UK's Pensions Act amendment, laws and systems promoting SRI were also established in other European countries, and European SRI expanded*8.

In 2006, the UN established the Principles for Responsible Investment (PRI) and introduced the concept of ESG factors, taking the initials of Environment (E), Social (S), and Governance (G). The UN argued that ESG factors could affect portfolios and called on institutional investors to consider ESG factors. As a result, many institutional investors, mainly in the West, supported and signed the PRI. It can be said that after the establishment of the PRI by the UN, the ESG investment market in the West expanded rapidly, and ESG investment became the mainstream of Western financial markets.

The PRI advocates Responsible Investment (RI), which uses integration and engagement as its main investment methods and has economic return as its sole purpose. Integration is an investment method that systematically incorporates ESG factors into traditional financial analysis. Engagement is where ESG investors, as shareholders, seek improvements in a company's ESG factors through dialogue with corporate management. The investment methods of Japanese ESG investors (mainly pension funds and pension asset management companies) are also centered on integration and engagement.

In this article, I have outlined the historical transition of investment in the West, which began with ethical investment in the early 20th century and developed into current ESG investment through SRI. I believe that even if the appearance of these investments in the West changes, an investment philosophy based on Christian ethics runs through their foundation. As mentioned earlier, Wespath, established in 1908, began asset management by inheriting biblical ethics and Wesley's faith. SRI for the purpose of anti-Vietnam War and anti-apartheid in the 1970s and 80s was a denial of war and violence, and a struggle for the protection and respect of human rights. Furthermore, the PRI's responsible investment or ESG investment, which has economic return as its sole purpose, appears at first glance to be unrelated to ethics. However, I believe that using ESG factors as investment criteria means evaluating the quality of environment, society, and governance, and involves making ethical value judgments accompanied by judgments of good and evil.

To further confirm the ethical nature of ESG investment, I would like to return to the starting point of ESG investment and consider the basis on which churches, which exist in the world of faith, began equity investment, which can be called the most secular. On this point, there is an academic paper that interviewed the Church of England and the Methodist Church of Great Britain, stating that the ethical investment of churches is based on five biblical principles: Creationism, Stewardship, Agapism, Witness, and Engagement. Additionally, the paper describes the ethical investment of churches as an attempt to improve corporate behavior and social justice*9. Regarding the five principles of the Bible, I will summarize them with reference to the lecture notes on "Christian Studies" by Professor Kosuke Nishitani (currently Professor Emeritus) of Aoyama Gakuin University.

Creationism means that "God created man in His own image" (Genesis 1:27, Old Testament); that is, humans are beings with dignity (character) in their reason, free will, and ethical judgment. And humans, as beings slightly inferior to God, were given a special position and qualification to manage the world. This is the second principle, "Stewardship." The third, "Agapism," refers to God's promise of salvation and unconditional grace toward humans. Humans respond to this with trust and gratitude. This relationship between God and humans becomes a mirror for relationships between humans. Christians who have received the grace of unconditional love from God bear the mission of reflecting the relationship between God and humans in the relationship between people and the world (neighbors) as the fourth principle, "Witness." This mission is the fifth principle, Engagement.

However, engagement in the ethical investment of churches is a concept that implies a more concrete involvement between the church and real society. In fact, the Methodist Church of Great Britain and the Church of England engage in efforts to encourage companies to improve problematic areas as shareholders.

From the above considerations and the history of investment in the West, I believe that the philosophy of "transforming companies and society through investment" based on the five principles of the Bible also runs through the foundation of current ESG investment in the West.

ESG investment in Japan has developed rapidly since 2015. In 2014, the Financial Services Agency established the Japanese version of the Stewardship Code for financial institutions, and in the following year, 2015, the Tokyo Stock Exchange established the Corporate Governance Code for listed companies. The two codes encourage companies to achieve sustainable growth and corporate value creation through constructive dialogue with investors. Furthermore, in September 2015, the Government Pension Investment Fund (GPIF), the world's largest public pension fund in terms of asset size, announced its signing of the PRI. As a result, asset management companies that manage funds entrusted by the GPIF were forced to start ESG investment.

Although ESG investment in Japan began under government leadership, major Japanese institutional investors are now seriously engaged in ESG investment. However, do all Japanese investors have a deep understanding of ESG investment? Compared to the West, ESG investment in Japan has a short history and has little experience in confronting ESG factors amidst major political, economic, and social changes. Moreover, ESG investment in Japan did not emerge from civil society but was born under government leadership.

In view of this situation, I believe it is necessary to provide ESG investment education to all executives and employees, including those at securities companies, in addition to investors such as pension funds and asset management companies. In ESG investment education, it is essential not only to acquire knowledge but also to foster an investment philosophy. Five years ago, when I examined textbooks from the CFA Institute (Association of Securities Analysts) in the US, I was surprised to find explanations of Bentham/Mill's utilitarianism, economist M. Friedman's ethical egoism, Kant's deontology, and Rawls's theory of justice. Moreover, they were listed in corporate finance textbooks, not professional ethics textbooks. I believe that ESG investment education that fosters an investment philosophy, including basic concepts of ethics, is an urgent issue in Japan.

Considering the current situation in Ukraine, it seems that a yellow light is flashing for the Paris Agreement's "1.5°C target." ESG investors may begin to waver. However, precisely because the world is in turmoil and division, I believe Japanese institutional investors need to return to the starting point of ESG investment and establish an investment philosophy of "transforming companies and society through investment." To that end, I believe it is essential to implement ESG investment education for all Japanese institutional investors and foster an investment philosophy.

* 1 According to Global Sustainable Investment Alliance (2020), Global Sustainable Investment Review 2020. GSIA | (Accessed March 8, 2023).