Is your portfolio at risk from the low-carbon transition?

Please note: This article is designed to be thought leadership content, to offer big picture views and analysis of interesting issues and trends that matter to our clients and the world in which we live. It is not designed to be taken as expert advice, investment advice or a recommendation, and any reference to specific companies is therefore not an opinion as to their present or future value or broader ESG credentials.

Reliance upon any of the information in this article is at the sole discretion of the reader. Some of the views and issues discussed in this article may derive from third-party research or data which is relied upon by Barclays Private Bank and may not have been validated. Such research and data are made available as additional information for the reader where appropriate.

Key points

• The shift to a lower-carbon world is having increasing consequences for companies and investors alike. The risks of such moves are economic as well as environmental. The more that is understood about such portfolio exposures, the better they can be managed.
• Policy and legal, technology, market and reputational risks are four key risks that companies face in the transition to a low-carbon economy. As increasingly being seen, businesses that are perceived as acting too slowly or making unsupported claims can lead to greenwashing complaints, with potential consequences to bottom lines.
• Conducting risk assessments of your portfolio and applying climate-scenario analysis can help you to assess and anticipate how the transition to lower-carbon economy might affect valuations.
• The longer that governments and companies take to address climate change, the more severe potential transition risks and therefore impact on portfolios are likely to be. So, beware of ignoring or dismissing transition risks in the short-term.

Climate change is not only an environmental issue; it’s an economic one. As such, the global economy needs to transform into a low-carbon one. 

Like any structural change, this will have winners and losers. Industries and companies that do not adapt are at risk of decline or disappearing. So too are investors’ portfolios holding investments in such sectors. 

The financial risks that arise from the shift to a lower-carbon economy give rise to what the Task Force on Climate-Related Financial Disclosures (TCFD)¹, calls “transition risks” which are complementary to the “physical risks” reviewed in our Market Perspectives publication, in May’s article, ‘Making portfolios more weather resistant’. 

Here, this article breaks down why these risks matter from a financial perspective and provides actionable insights to help you to position your portfolio effectively. 

Understanding transition climate risks

Governments, companies and society are all adapting to climate change, some more so than others. Investors should consider the transition risks, and opportunities, that arise from these changes as they seek to protect and grow their wealth and make a positive contribution to our world. 

The TCFD identifies four main types of transition risks: policy and legal, technology, market, and reputation².

Policy and legal risks

To deliver on their Paris Agreement commitments, governments are adopting regulations and policies designed to reduce carbon emissions or promote adaptation to climate change. 

Policy levers include stricter regulations on emissions, carbon pricing or taxes, emissions-trading systems and more climate-related disclosures. As such, firms face the additional costs of compliance or the forgone revenues from not complying. 

At the same time, companies and governments are more exposed to litigation from their actions, or lack thereof, relating to climate change. Since 2017, the cumulative number of climate-related court cases has doubled, reaching 2,180 climate-related cases filed in 65 jurisdictions by the end of 2022³. 

Claims cover a diverse set of causes. For example, historically high emitters are at risk of legal action for contributing to climate change. More broadly, complaints of corporate greenwashing are more common, with the threat to reputation and revenues being ever present.

Technology risks

Technological risks arise from the rapid development and deployment of new ways to support moves to a low-carbon economy, in the familiar process of ‘creative destruction’.

Companies that fail to innovate or adapt to new technologies risk becoming obsolete. Prime examples include shifting energy production from fossil fuels to renewable energy, or automotive firms converting from internal combustion engines to electric drivetrains. 

Adoption of new technologies can begin slowly, especially given the competing solutions. Businesses may believe that such proposed solutions are unviable or doubt that they have time to switch. However, once adoption reaches a tipping point and accelerates, they face greater risk of disruption. 

Market risks

Market risks arise from the increased awareness of climate change and the impact it has on supply and demand for certain commodities, products and services.

Consumers, corporations and governments, not wanting to worsen climate change, are shifting spending to more sustainable options. Conversely, companies with high emissions, or not seen to be making the transition quickly enough, may see less demand or their assets repriced lower. 

As well, firms may suffer from increased production costs due to scarcity, higher demand or to reflect externalities. Input costs, such as for energy, water or natural resources, and output requirements, such as treatment of waste water, could increase as market dynamics change. 

Reputation risks

Reputational risks concern the perception of companies by consumers, regulators or peers to their attempts to adjust, including how they present themselves to the outside world. In a social media age, such risks can harm a company’s bottom line quickly. 

Reputations can be affected on an absolute basis, perhaps an incident for a single company, or on a relative basis, that is how one company compares with others. 

Reputational damage can affect a firm’s attractiveness to clients or suppliers, the degree of engagement from stakeholders and potential stigmatisation. Without reconciling reputational damage, in the worst case, a firm may lose its “license to operate” socially or legally.

How transition risk affects industries

Efforts to transition to a low-carbon economy can affect companies’ revenues and profits (see chart⁴). For example, greener buying preferences or damage to reputation from greenwashing may hit sales. Making required technology changes or paying for emissions will increase costs.

The extent and nature of transition risks, though, will vary by industry. When assessing specific sectors for policy risks and technology opportunities, the aggregate value at risk can be substantial. It will matter more for “hard to abate” sectors that find it tougher to cut their carbon footprint. For example, steel or cement industries face greater transition risks. However, even apparently unrelated industries, such as fashion, food or tourism, will also be affected. 

Aggregate Value at Risk by Sector from 1.5C Net-Zero transition scenario

Potential financial impacts by sector of from policy risks and technology opportunities 

As well, the four transition risks can be intertwined and reinforcing. Generically, a policy risk that requires new technology may add to reputational risk, if a firm does not make progress, thereby affecting consumer demand ( a market risk) and potentially leading to litigation (a legal risk). 

The table below summarises some of the transition climate risks for specific industries and their effects on a company’s value chain⁵.

Source: Barclays Private Bank, May 2024

Approaches to assess transition risks in portfolios

To mitigate the transition risks on their portfolios, investors could adopt several practical strategies: 

1. Conduct comprehensive risk assessments: Evaluate the exposure of investments to transition risks across different sectors, regions and asset classes. Consider all four transition risks as well as their interdependencies. To identify specific risks, assess environmental records, past R&D and capital investments and transition plans to adapt to the transition. 

2. Utilise climate-scenario analysis: Model potential faster or slower policy change scenarios and assess their impact on potential investment performance. Consider factors such as how orderly, including the speed and consistency, policy changes will be made against the risk of a disorderly process, perhaps one where policies are delayed or divergent. 

3. Assess transition targets, plans and reporting: Review current sustainability commitments, corporate disclosures on exposure to transition risks and stated transition strategies and pathways. Evaluate transition plans for credibility and assess corporate capabilities to deliver large-scale, business-model transformation programmes. 

4. Monitor regulatory developments: Stay informed about regulatory changes and policy developments related to climate change. Regularly review how new regulations could affect specific industries, both domestically and for imports, as well as how the changes might drive investment flows.

5. Integrate climate risk metrics: Incorporate transition-risk metrics, such as exposure to carbon-related assets or to changes in energy costs or carbon pricing, into investment decision-making processes. Evaluate scale and nature of climate risks on portfolio performance using quantitative tools and models, and adjust asset allocations accordingly.

Prepare your portfolio for tomorrow's world 

Climate transition risks can be more subtle than the physical effects of climate change. However, they can still hit the value of investment portfolios. 

The longer governments and companies take to address climate change, and the larger its physical impacts become, the swifter and more severe the action needed will likely be. Furthermore, complacent investors may be more surprised by any sudden action that amplifies transition risks.

Making your portfolio more resilient to transition risks requires actively assessing and anticipating how the world might move to the required low-carbon economy. While impossible to predict perfectly, preparing your portfolio for such a shift should help you to reach your long-term goals more effectively.