Section 6 – Due diligence phase

Module 9 – Transition risk assessment

As policies, technologies and market preferences evolve, transition risks can fundamentally alter borrower credit quality, asset values and sector dynamics. Institutions that fail to identify and manage these risks may face financial loss, regulatory sanctions or reputational damage.

The following core principles can help organisations approach transition risk assessment in a structured, credible and practical way:

• Core principles

  Proportionality

  Prioritise resources and analysis on the most material exposures. For less material exposures, apply simplified rules-based screening.

  Scenario-based assessment

  Acknowledge the inherent uncertainty of transition risks. Use scenario analysis, especially qualitative explorations of future conditions, to build a forward-looking view of potential outcomes.

  Consistent reasoning and outputs

  Apply organisation-wide rubrics, scoring templates or decision trees to ensure teams use shared criteria when engage with transition risks. Ensure assessment processes and outputs are well-reasoned, documented and useful for decision-making.

The following terms can become a common language when discussing transition risks:

1. Policy risk: the risk of financial impacts from domestic or international climate policies such as carbon taxes, emission trading schemes, or fuel bans.
2. Legal risk: the risk of litigation related to climate inaction, greenwashing or failure to meet climate targets.
3. Technology risk: the risk of disruption from emerging cleaner or cheaper technologies
4. Market risk: the risk from changing consumer demand, investor sentiment or commodity prices affecting production and competitiveness.
5. Reputational risk: the risk of harm from changing social expectations.
6. Stranded asset: an asset that becomes economically unattractive or obsolete due to transition dynamics.
7. Scenario analysis: exploring possible future conditions and their effects on markets, borrowers and assets (See Tool 1).

Prioritising sectors for transition risk assessment

Transition risk assessment is a targeted exercise aimed at managing FI exposure to high-emitting sectors where policy, market and technology-driven disruption is both material and probable.

Not all sectors face equal transition risk. For low-emitting sectors, such risks are often immaterial or indirect and can usually be further minimised through simple changes in processes. It is therefore practical to avoid devoting significant resources to transition risk assessment in sectors with negligible emissions or otherwise robust decarbonisation pathways.

• High-emitting sectors
  These are economic sectors that contribute significantly to global GHG emissions through energy-intensive production, heavy consumption of fossil fuels or direct GHG releases such as methane leaks.

  Examples include energy production, heavy industries and agriculture.

• Hard-to-abate sectors
  These are a subset of high-emitting sectors that face significant technological, economic or operational barriers to decarbonisation. This is often due to the volume of production-linked emissions, the lack of viable low-carbon alternatives, or the long lifespans of existing capital infrastructure.

  Examples include cement, steel, shipping and aviation. While energy production is a high-emitting sector, it is not considered as hard-to-abate because renewable energy technologies now offer cost-competitive alternatives to fossil-fuel-based generation.

• Low-emitting sectors
  In contrast to the above, low-emitting sectors have minimal direct/indirect GHG emissions relative to economic output.

  Examples of low-emitting sectors include education, professional services, and households.

Transition risks are greatest in high-emitting and hard-to-abate sectors for several reasons:

• Most transition risk outcomes, such as stranded asset, regulatory shocks and reputational damages – are concentrated in these sectors. They account for around 75 per cent of global GHG emissions (according to PACTA) and face the steepest decarbonisation challenges.
• Global and local regulations such as IFRS S2 and investor coalitions including CA100+ and GFANZ are demanding transparency and management of exposures in ‘climate-critical’ sectors.
• In hard-to-abate sectors, decarbonisation pathways remain uncertain, dependent on unproven or costly technologies, and are subject to shifting policy frameworks and evolving market dynamics. This makes strategic planning both challenging but also essential.

For each prioritised sector, FIs should identify and track key risk drivers – such as emissions intensity, policy sensitivity and the availability of decarbonisation technology – to determine an overall transition risk score.

Key goals and outcomes for a transition risk assessment

A transition climate risk assessment should systematically identify, quantify and manage exposures to climate-related value shocks, particularly in high-emitting or hard-to-abate sectors. While transition risks are harder to quantify than physical risks, the lack of data should not prevent institutions from carrying out an assessment. The main goal is to deliver a risk-informed foundation for credit and client engagement decisions, while supporting regulatory compliance and the long-term preservation of value.

• Key goals for a transition risk assessment might include:

  Identifying material transition risks

  Pinpoint potential exposures arising from transition dynamics such as policy shocks or technology disruption.

  Assessing alignment with sectoral decarbonisation pathways

  Compare the client’s implied decarbonisation trajectory against relevant national and science-based targets, as well as the targets and trajectories of peers in the same sector.

  Evaluating transition readiness and credibility

  Assess the client’s transition plan based on its strategic intent and technical feasibility.

  Quantifying financed emissions

  Measure asset-level GHG emissions, both absolute and relative, and determine whether the financed emissions share exceeds the organisation’s defined risk appetite. – See also Module 10.

• Key outcomes from a comprehensive asset-level transition risk assessment

  Risk-rated project or client profile

  A clear and documented assessment of the project’s transition risk level, supported by rationale and sector-specific references.

  Actionable risk mitigation steps

  Identification of key risk mitigants or escalation criteria, including provisions in the financing agreement as well as metrics for ongoing client engagement and climate performance monitoring.

  Enhanced credit risk decision-making

  Structured integration of climate risk findings into due diligence and risk monitoring processes.

  Improved client engagement

  Evidence-based engagement with clients on transition weaknesses and opportunities, supporting alignment and sustainable value creation over time.

  Portfolio impact analytics

  Aggregated data on assessed exposures that informs overall portfolio-level transition risk, concentration limits and strategic steering.

Guidance 7a: Example of a sectoral heatmap of transition risk drivers

Guidance 7a illustrates typical high-emitting sectors and their sensitivity to policy, technology and market shifts. FIs should develop lookup tables to rapidly screen for transition-sensitive sectors.

Guidance 7b: Sector-agnostic qualitative transition risk assessment questionnaire

Assessing transition risks can be challenging. While policy risks can be modelled through simulating different carbon pricing regimes, many aspects of transition risk are qualitative and require human judgment. This often makes assessing transition risk more time-consuming than automated physical risk assessments.

Nonetheless, when cross-functional teams applying consistent reasoning for rules-based decisions, supported by structured discussion and clear documentation, qualitative assessments can be highly important for decision-making. Using underlying risk drivers to describe levels of transition risk can be an effective approach (see Guidance 7a).

• Basic inputs for asset-level transition risk assessment can include:

  Sector classification of client or project

  Use the sector classification to conduct an initial mapping of the sector’s decarbonisation potential and the relevant geographic policy landscape, based on desk research or input from subject-matter experts.

  Client transition plans (if any)

  Gather information on the client’s climate commitments, decarbonisation targets, capital expenditure (capex) for transition-related initiatives and the extent of alignment with sectoral decarbonisation pathways

• Additional inputs for advanced transition risk assessments can include (Advanced FIs):

  Asset-level characteristics

  Include details such as asset age, remaining economic life, existing mitigation measures, retrofitting potential and core equipment, to assess the degree of technology lock-in over the asset’s lifetime.

  Regulatory environment analysis

  Review relevant climate-related regulations and international policies that could affect operations, such as tariffs or export bans.

  Market environment analysis

  Consider market trends, commodity price scenarios and evolving supply chain expectations that may influence the asset’s transition risk profile.

Guidance 7b offers a practical reference for developing an internal transition risk-related questionnaire that can evaluate transaction-level transition risk from several perspectives.

Guidance 7c: Example information flow of an asset-level transition risk assessment

Guidance 7c offers a step-by-step method for assessing transition risk at the transaction level, helping to determine whether a particular project presents a high transition risk.

• Data quality and availability

  • Asset-level emissions and transition plan data may be estimated, out-of-date or inconsistent across assets and sectors
  • Reliance on proxies or industry averages can reduce assessment precision, introducing (more) uncertainty

• Scenario and policy uncertainty

  • Future climate policy, carbon pricing and technological cost curves are inherently uncertain
  • Risk ratings may be systematically biased by input scenario selection
  • Differences in regional policy ambition can materially alter risk profiles

• Transition plan credibility

  • Client-provided targets may lack sufficient detail or credibility; alignment with science-based pathways is not easy to verify without subject-matter expert inputs
  • Even then it may still be infeasible due to operational time constraints

• Model and methodology limitations

  • Asset-level assessments are subject to the limitations of current modelling tools and their underlying assumptions
  • Differences in time horizons between transition scenarios and typical loan tenors can create misalignment

• Overlaps between physical and transition risks

  • Some transition risks may be linked to or triggered by physical risks (e.g. a severe heatwave sparking a wave of climate-related litigation)
  • In most realistic forward-looking projections, the science suggests that both physical and transition risks will play out in transition pathways due to locked-in levels of carbon emissions

Qualitative transition risk assessments should begin with a strong emphasis on transparency, proportionality, and practicality. Approaches should be viewed as iterative, with a focus on building internal capacity, strengthening regional collaboration, and openly communicating strengths and limitations of assessments to boards, regulators, and clients. This can help to build understanding and resilience.

Guidance 7d: Example output from an asset-level transition risk assessment

A transition risk assessment should deliver the following outputs:

1. Overall transition risk rating: classifying the asset in question by exposure level (high, medium or low) based on emissions intensity, policy risk and technology readiness.
2. Alignment assessment: analysis of how the asset or client’s decarbonisation plans compare with sector decarbonisation benchmarks.
3. Financed emissions share (for Advanced FIs): scenario-based projections of the institution’s financed emissions share if the project proceeds.
4. Impact on credit decision and additional risk mitigation recommendations: guidance on risk grading, loan pricing, tenor, financing opportunities for decarbonisation technologies, clauses to include in financing agreements and metrics for ongoing client monitoring.

Guidance 7d presents an example transaction-level risk assessment output that could help institutions determine the conditions under which they would proceed with project financing.

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