Financial Risk and the Transition to a Low Carbon Economy
Climate change creates two types of potential risks for financial institutions:
- Physical changes – both through gradual change and extreme weather events which are likely to alter the supply and demand dynamic of many industries and lead to physical damages to assets.
- The transition to a low carbon economy will alter the financial viability of a part of the capital stock and business models, also impacting on the performance of assets and portfolios.
To date, risk factors resultng from climate change and the transition to a low-carbon economy are generally not considered by mainstream risk assessment and management frameworks. This paper reviews emerging and proposed models for climate stress testing and concludes that there is no fundamental barrier to integrating climate and carbon risks into financial risk and valuation models. However the time horizon by which risks are considered remains a critical obstacle preventing consideration of longer term risks.