Transition Risk

Transition risk refers to the financial risks that could result from the process of adjusting to a low-carbon economy. These risks arise from changes in policy, technology, and market sentiment as the world takes action to mitigate climate change. The ISSB and other mandatory climate disclosure frameworks require companies to assess and report on the transition risks and opportunities that could materially impact their business prospects.

Transition risk can manifest in five main subcategories:

1. Policy Risk: Potential financial impacts from changes in laws, regulations, or government policies.
2. Legal Risk: Exposure to lawsuits related to climate inaction or misrepresentation of climate efforts.
3. Technology Risk: Financial implications of innovations that support the transition to a low-carbon economy.
4. Market Risk: Changes in supply and demand for certain commodities, products, and services.
5. Reputational Risk: Potential damage to a company's image due to stakeholder perceptions of its climate action or inaction.

The most critical factor in assessing transition risk magnitude is the interplay between carbon budgets and carbon pricing. As carbon budgets tighten over time, carbon prices are expected to rise, creating increasing financial pressures for high-emitting assets and activities.