Why climate mitigation scenarios should factor in transition risk?
Principles for Responsible Investment (PRI) 08/12/2021
"(...) Within sustainable finance, institutional investors face increasing demands to assess their exposure to climate risk. Climate mitigation models that factor in investor expectations are a key component of that.
Climate change is recognised today by financial supervisors as a source of financial risk for institutional investors.
Mitigating and adapting to climate risks requires us to change our production systems and lifestyles at such a scale and pace that most economic activities are affected, whether positively or negatively. As a result, large portions of financial portfolios are affected too, because they are currently invested in such activities.
Besides the physical impacts of climate-related hazards, financial actors need to consider climate transition risk. The term does not imply that the transition to a low-carbon economy, per se, generates risk. Rather, the risk emerges if the transition is delayed and then occurs suddenly, what is referred to as “disorderly” in the literature.
The window of opportunity to stabilise the global temperature below 2 degrees C closes in the next 2-3 decades. Hence, the later the transition starts, the faster it needs to be, bringing about large adjustments in asset values that investors may not be able to fully anticipate or hedge against.
In our paper, published in Science in May 2021, we explore the importance of factoring investors’ expectations and reactions into the climate mitigation scenarios used by financial authorities and investors belonging to the Network for Greening the Financial System (NGFS). Doing so has important implications for financial stability, for risk management and for the fate of the low-carbon transition overall. (...)"
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