It is expected to emerge from a disorderly transition to a low-carbon economy. Transition risk is defined as a situation in which climate policies and regulations are introduced late and suddenly, or technological shocks occur that negatively affect fossil fuel and high-carbon firms’ performance, and thus the value of their financial contracts.
For instance, a late introduction of a carbon tax would lead to larger costs and lower profits for firms that extract, produce or use fossil fuels for their business, being fossil fuel combustion a main driver of CO2 emissions. This economic loss can translate then in a financial loss, whereby the loss in firm’s performance translates to a negative adjustment to financial assets or an inability to repay outstanding loans, eventually affecting investors through carbon stranded assets (i.e. assets whose value could decrease abruptly as a result of a phase out of fossil fuels and high-carbon activities).