Transition Risk: No Investor Action Equals US$2.2 Trillion Loss Starting 2026

In order to support investors in developing comprehensive strategy around climate, Responsible Alpha is publishing a two-part series on financial climate risk. In part one, we reviewed physical climate risk and provided strategies for quantifying it. Here, in part two, we will explore transition risks, including identification, quantification, and management.  

Why This Matters 

• 2.2 Trillion USD Loss Starting 2026: A disorderly transition in 2026 entails an estimated transition cost of US$2.2 trillion (Sustainable Finance Observatory)  

• 150 Billion USD Loss Each Year Delayed: For every year transition is delayed, financial institutions could rack up additional costs of US$150 billion annually as a result of changes in market and credit risk (University of Oxford). 

Details 

Transition risk refers to the hurdles and pitfalls associated with the global shift to a low-carbon economy. Unlike physical risks from climate change, such as extreme weather and rising sea levels, transitional risks stem from policy changes, technological shifts, evolving market preferences, and reputational pressure. While grappling with the most tangible consequences of climate change is essential, investors, corporations, and intermediaries must address transition risks simultaneously. 

As outlined by the Network for Greening the Financial System (NGFS), delayed or disorderly climate action will significantly heighten both transition and physical risks, compounding instability in the financial system.  

Task Force on Climate-related Financial Disclosures (TCFD) reiterates that unmanaged transition risk can result in severe capital misallocation and sudden loss of value, particularly in carbon-intensive sectors. While varied, cost estimates demonstrate universal consequences of ignorance.  

Large-scale shifts in the labor force, reallocation of investment, and rapidly shifting energy demand also pose financial threats for those not well prepared.  

More than a theoretical threat, transition risk is a material financial issue. Indeed, market players must balance short-term risks of ill-planned or uninformed action with the longer-term consequences of insufficient action. While imperfection may invite additional transition risk, late and uncoordinated efforts generate incomparable amounts of transition and physical climate risk, some irreversible (NGFS). Action now can circumvent “worst-case” scenarios and provide investors with the stable and adaptive capital market conditions integral to financial success.  

Identifying Transition Risk 

Transition risks fall into four main categories: 

1. Policy and Legal Risks: Arising from current and future climate policies, carbon pricing, and litigation related to emissions or failure to disclose climate risks. 

2. Technology Risks: Emergence of low-emission alternatives that disrupt incumbent business models. 

3. Market Risks: Shifting customer demand, supply chain disruption, and declining market share for carbon-intensive products. 

4. Reputational Risks: Public or stakeholder backlash from perceived climate inaction or greenwashing. 

Of note for industries with emission intensive physical assets is the risk of stranded assets, when infrastructure must be retired before the end of its useful life in order to meet emissions reduction targets. The cost of decommissioning stranded assets in the energy sector is an estimated $3.6 trillion, rising to $8 trillion when decommissioning costs for renewable energy, shipping, industrial, and landfill sectors (BNP Paribas). This costly burden is felt by corporations and investors who see returns disappear, and taxpayers who frequently subsidize decommissioned energy assets without benefit.  

Amidst the broad range of potential risks, identifying those which are most material depends on a firm’s size, jurisdiction, emissions profile, and climate accounting structure. Certain realities, like the rising cost of critical raw materials and increasing consumer preference for sustainable goods and services, will impact nearly all industries (Consumer Reports, Statista). Others are more industry specific, such as drastically altered demand for gas and oil producers and rapid adaptation required by traditional aerospace and auto manufacturers. However, regardless of individual effect, an unmanaged transition will yield large-scale financial risk. 

Source: NGFS, April 2019 

Methods for Quantification  

Best-in-class quantification of transition risk relies on a variety of climate scenario analyses to generate a comprehensive view. As with physical risk, TCFD provides a framework from which to begin analysis, which includes integration of scenario analysis into the strategic development, assessment to determine factors significant to the operation and finances of an organization or portfolio, recognition of all plausible climate outcomes (e.g., orderly, disorderly, and hothouse world scenarios) and their impact on operational costs, regulatory compliance costs, supply chains, and business interruption. Effective quantification and consequent management will require robust metrics to avoid misleading assumptions that disguise risk. For instance, the empirical relationship between operational emission intensity and climate transition risk reveals GHG emissions are not a simple proxy for climate risk.  

A Case for Opportunity  

Insufficient climate action threatens returns and well-being. However, perhaps the most motivating case for action on climate transition is the benefit of swift, smart action. In a far-from-close race, the economic benefits of an accelerated transition to a net zero economy far outweigh the costs.  

Effective net zero transition by 2050 represents an opportunity for global growth as well as firm specific opportunities, through capitalization of green innovation, alignment with cost saving policy incentives, and portfolio resilience through reallocation of capital towards future fit firms. Vast opportunity affirms that a well-managed transition enables not just risk avoidance, but value creation.  

Management and Action Items:  

Investors and corporations face a clear choice: act immediately and strategically or react later at a greater cost. While navigating transition risk is complex, the following actions can provide clarity and promote resilience: 

1. Set Science-Based Targets: Science-based targets support effective management of transition risk by aligning emissions reductions with anticipated policy and market shifts. Committing to targets through frameworks like SBTi prepares firms and investors for rising carbon prices and mounting regulatory and public pressure. By identifying where emissions, opportunities, risks are concentrated, firms can plan cost-effective decarbonization and avoid the financial shocks of delayed action.  

2. Invest in Firms Offering Climate Solutions: Using LLM’s to review firms, HBS found “high-climate solution firms,” or those offering services and technology to navigate transitional risks, respond positively to events signaling increased demand for climate solutions, showing “higher future profitability during periods of regulatory uncertainty,” following unexpected increases in climate concerns, and when climate plans are adopted by governments (Harvard Business School). These results indicate that climate focused investment can serve as a hedge for investors against transition risks as they increasingly begin to materialize. 

3. Disclose and Engage: Adopting robust climate disclosure frameworks, such as those established by the TCFD or standards under the International Sustainability Standards Board (ISSB), enables organizations to communicate clearly about risk exposure and progress. Transparent reporting both helps to identify vulnerabilities but also facilitates more effective responsible investment and ongoing dialogue with regulators, shareholders, and civil society.