Transition risk

Transition risk is the financial risk a business faces from the shift to a lower-carbon economy itself, rather than from climate hazards directly: new carbon pricing or regulation, shifting consumer and investor preferences, disruptive low-carbon technology, and reputational or litigation exposure tied to emissions. A coal-fired power plant and a fossil-fuel vehicle manufacturer both carry high transition risk even in a region untouched by physical climate hazards.

Assessing it typically starts from a company's or portfolio's scope 1, 2 and 3 emissions footprint and exposure to carbon-intensive activities, then models financial impact under alternative policy and technology scenarios, such as different shared-socioeconomic-pathways-linked routes to net zero, translating stranded-asset risk, compliance cost and demand shifts into a financial estimate. This differs from physical climate risk, which models damage from the climate itself; the two are usually assessed together because they can partially offset or compound one another, a company can face both falling demand and, separately, physical disruption to its facilities.

Transition risk sits at the center of financial-sector climate disclosure and ESG reporting, and regulators increasingly frame it using double materiality, the idea that a company must assess both how climate affects its finances and how its activities affect the climate. A common pitfall is modeling transition risk only under a single, often overly optimistic, policy pathway, and treating a low current-emissions footprint as low transition risk without accounting for exposure through the supply chain or customer base.