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

2023/04/05

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 size of Japan's ESG investment market was the third largest in the world at US$2.874 trillion, despite a significant gap compared to the US market's US$17.081 trillion and the European market's US$12.017 trillion.*1 Before 2015, only a very small number of institutional investors were engaged in ESG investment. The reason for the rapid development of Japan's ESG investment market in a short period lies in the policies of the Japanese government.

On the other hand, the ESG investment markets in Europe and the United States have a history of more than 100 years, and their origins can be traced back more than 400 years. Furthermore, equity investments by British and American Christian churches (hereinafter referred to as "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), "The history of the world has been made by religion and economics. [...] At times, religious motives are more intense than economic motives." 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, in a world where divisions are deepening due to Russia's invasion of Ukraine, it will serve as a guidepost for ESG investors.

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 sermon "The Use of Money" in the 1760 collection of sermons 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, "The Use of Money" continues to have a strong influence on Western society today, as evidenced by the then British Minister for Pensions quoting 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 that one should work diligently and earn as much as possible without wasting time, save as much as possible while avoiding luxury, and give as much as possible to the poor, except for what is necessary for oneself and one's family. This is an idea based on the biblical principle that God created humans not as owners of property, but as stewards.

Furthermore, as a major premise when acquiring money, Wesley warned against earning 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 today's 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 (hereinafter referred to as Wespath), established in 1908 by the Methodist Episcopal Church (now the United Methodist Church) as an institution to manage and operate pensions. Wespath began asset management by inheriting the ethics described 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 United States, excluding stocks of companies related to alcohol and gambling. At that time, Prohibition was in effect in the United States, and gambling was also prohibited nationwide. Prohibition inherited the strict Puritan faith. Puritan thought had a great influence from before the founding of the United States 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 United States. 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 the establishment of The Pax World Fund, a publicly offered investment trust (SRI fund) that 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 United States.

In the 1980s, apartheid in the Republic of South Africa (hereinafter referred to as South Africa) became a target of international criticism, and the United Nations 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, the largest providers of funds to South Africa, 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, institutional investors entered the SRI market as European governments promoted SRI as a policy. The amendment to the Pensions Act enacted 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 to the Pensions Act. After the UK's amendment to the Pensions Act, laws and systems promoting SRI were established in other European countries, and SRI in Europe expanded.*8

In 2006, the United Nations 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, agreed to and signed the PRI. After the establishment of the PRI by the UN, the ESG investment market in the West expanded rapidly, and it can be said that 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.

This article has provided an overview of the historical transition of investment in the West, starting with ethical investment in the early 20th century and developing through SRI into current ESG investment. 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 in the 1970s and 80s aimed at the anti-Vietnam War and anti-apartheid movements 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 focuses solely on economic returns, may seem unrelated to ethics at first glance. 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.

Furthermore, to confirm the ethical nature of ESG investment, I would like to return to the starting point of ESG investment and consider the grounds on which churches, which exist in the world of faith, began equity investment, which can be said to be the most secular. Regarding this point, there is an academic paper based on interviews with 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 I will summarize the five biblical principles 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), 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 for 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 as shareholders to encourage companies to improve problematic areas.

Based on the above considerations of the history of investment in the West, I believe that the philosophy of "transforming companies and society through investment" based on the five biblical principles 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 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 GPIF's funds 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 there is 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 firms, 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 the textbooks of 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 not in a textbook on professional ethics, but in a textbook on corporate finance. 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 "1.5°C target" of the Paris Agreement. ESG investors may begin to waver. However, precisely because the world is in a state of confusion and division, I believe that 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).