Why Investors Need To Be Thinking About Climate Tipping Points

Why Investors Need To Be Thinking About Climate Tipping Points

The world has now surpassed the 1.5°C global warming threshold over pre-industrial levels, a landmark benchmark for net zero ambitions. This wasn’t a number casually tossed out by a group of scientists over drinks. It’s grounded in rigorous scientific research that showed that exceeding this threshold could trigger irreversible and potentially catastrophic damage.

But what does that damage look like? Why does it matter? And how will it impact the future? These are essential questions long-term investors must ask and be prepared to answer.

A study from the Potsdam Institute for Climate Impact Research (PIK) warns that under current global policy trajectories, we are on course to breach multiple climate 'tipping points' – thresholds beyond which critical Earth systems may undergo irreversible change. These include the collapse of ice sheets that stabilize sea levels, mass coral reef die-offs from ocean acidification and the breakdown of carbon sinks due to deforestation.

These aren’t future hypotheticals, they’re already unfolding – and at a faster pace than scientists expected.

So why am I telling you this? Because if you hold assets that depend on – or are exposed to -- major planetary systems, or are in regions vulnerable to climate shocks, this matters to you.

One of the most effective ways for investors, especially those with long-term horizons or significant balance sheet exposure, to mitigate climate risk, including acute shocks, is through advanced scenario analysis. The most credible approaches are grounded in industry-leading integrated assessment models (IAMs), which connect physical climate outcomes with financial and economic consequences (see Verdantix Best Practices: Climate Scenario Analysis).

I’ve been exploring IAMs in my research on transition risk (more on that soon*). Many are supported by widely recognized frameworks such as the Network for Greening the Financial System (NGFS), the International Energy Agency (IEA) and the Intergovernmental Panel on Climate Change (IPCC). Others are more bespoke.

For example, PIK used the IMAGE model, an IAM widely applied in climate analysis, under the Shared Socioeconomic Pathways (SSP2) scenario. It found that, under current policy conditions, the world is expected to breach eight of the nine planetary boundaries by 2050. Integrating scenario analysis with robust IAMs allows investors to stress-test non-linear, compounding risks – also known as tail risk events – which, when incorporated into financial models, can significantly challenge traditional assumptions about risk and return.

While IAM-backed scenario analysis isn’t a forecast, it is a critical exercise for investors to identify where they may be most exposed and where irreversible portfolio damage could occur if compound climate events materialize. That said, the approach has limitations. Chief among these is uncertainty: the timing and magnitude of future climate impacts remain highly variable, which makes planning and investment decision-making more complex.

This uncertainty has contributed to slow adoption. In a recent MSCI study on commercial loan book exposure to climate risk, only 20% of banks reported using scenario analysis as part of their risk management practices.

That’s beginning to change. Climate financial data and analytics providers are stepping up with more advanced scenario analysis tools, some backed by IAMs. Risilience, for example, offers functionality to model policy shocks and assess how regulation-driven transition risks could affect asset values. Clarity AI has recently incorporated climate tipping points into its Climate Scenario Analysis solution, linking them to macroeconomic indicators such as GDP and inflation. These innovations help investors better understand the ripple effects of climate risk across portfolios and take proactive steps before the tipping points tip.

Climate thresholds are no longer distant. For investors, the question is not if but how climate risk will affect portfolios. IAM-based scenario analysis doesn’t predict outcomes, but it helps identify where exposures lie and how they might compound. As climate challenges grow more complex, incorporating tail risks into investment planning is no longer optional – it’s essential for holistic risk management.

*I'm currently working on our Smart Innovators report on transition risk data and analytics, which is set to be published in June. Clients will be able to access the full report through our research portal. If you're a corporate practitioner, you can also access it for free through our Vantage platform.