Connecting Planetary Climate Risk to Financial Climate Risk
6 August 2025
Climate change is propagating disruption across three interconnected systems: the planetary, the economic, and the financial. Investment professionals must learn how physical climate impacts in the planetary system may drive economic losses and financial instability if they are to manage their portfolios effectively.
Parsing climate risks is an emerging discipline. What makes it particularly challenging is that the transmission channels through which planetary-level disruptions translate to economic and financial risks are poorly understood, and not fully mapped. Moreover, the interactions between these three systems can produce non-linear effects and feedback loops that are difficult to model, and cause investors to under- or over-estimate certain risks.
In this article, we unpack a typology of planetary, economic, and financial climate risks introduced by the Columbia Center on Sustainable Investment, examine how certain planetary risks — including climate tipping points — are relevant to economic and financial systems, and stress the importance of considering climate risks to all three systems in a holistic fashion.
Planetary Risk: A Changing Earth
Planetary risks emerge from the Earth’s physical response to greenhouse gas emissions. They include both short-lived, high-intensity ‘acute’ hazards — such as hurricanes, wildfires, and floods — and slow-onset, long lasting ‘chronic’ stresses like sea-level rise and worsening drought. These risks may accelerate as the climate nears or passes tipping points — thresholds that, if crossed, would unleash irreversible environmental catastrophe. Significant tipping points include permafrost thaw — which would release methane, a highly potent greenhouse gas –— and collapse of major ocean currents like the Atlantic Meridional Overturning Circulation (AMOC), which transports vast quantities of heat to mid-latitudes.
Some of these slow-onset planetary risks, like sea-level rise, may only fully manifest over the long term. The time horizon over which climate change will amplify extreme weather events and other 'acute' risks is also uncertain. What we know is that physical disruptions will become more frequent and intense as the climatic system reacts to human-induced warming and approaches these tipping points, with implications for economic and financial systems. How these risks spillover into the other two systems, however, is an ongoing challenge for risk modellers.
Therefore, while addressing planetary risks is a global responsibility, and most appropriately managed by governments and multilateral institutions, no financial actor can or should ignore them.
Economic Risk: Real-World Losses
Economic risks materialise when the physical responses highlighted above disrupt productive capacity, devalue assets, and convulse labour markets. Such risks include:
● Losses from extreme weather damaging crops, property, and infrastructure.
● Climate-driven migration changing the distribution of labour and increasing the burden on government budgets.
● Increased aridity raising the price of core commodities.
In addition, policy responses to emerging planetary risks — and the evolution of technology — can create risks of their own. These are what are called ‘transition risks’, and they can also disrupt economies by catalysing rapid systems change. For example, a sudden shift in government subsidies to the fossil fuel industry, or the rapid emergence of commercially attractive energy alternatives, like solar and wind energy, could dramatically erode the profitability of oil and gas majors, and boost that of the renewables sector.
Governments, central banks, insurers, and public finance administrators bear primary responsibility for managing these economic risks. But since many of their effects are likely to cascade through the financial system, they should be a focus of investors too.
Financial Risk: The Portfolio Problem
Financial risk arises when economic losses influence the credit, market, and liquidity characteristics of financial assets. This is where climate risk becomes material for investment professionals. The transmission channels through which economic risks ripple through markets and investment portfolios are myriad, and can both amplify and attenuate resulting financial impacts. Here are some examples:
● Extreme weather events impair a power utility’s infrastructure, disrupting revenues and increasing the credit risk associated with its outstanding bonds.
● An extended period of high temperatures causes drought conditions in a major waterway, disrupting supply chains and impacting the sales of a leading retailer, causing its stock price to fall.
● Shifting weather patterns reduce the arable land available to an agribusiness, forcing revenue projections lower and curbing their access to third-party liquidity facilities.
● The rapid advance of battery technology causes electric vehicle take-up to occur much faster than expected, lowering demand for oil and decimating the enterprise values of hydrocarbons producers.
Not all financial assets are directly exposed to every planetary and economic risk. But they are susceptible to abrupt corrections when participants adjust their forward-looking projections. Consider the adoption of the 2015 Paris Agreement, which analysis suggests triggered a noticeable drop-off in fossil fuel equity values.
Quite how physical and transition risks are priced into the value of assets will vary by their exposure, vulnerability, and the nature of the climate-related hazards they face. This will also vary by asset class. For example, for certain debt instruments — like municipal bonds — climate risks may be ‘priced in’ via credit downgrades and a steepening of yield curves in response to a local governments’ lack of climate preparedness. For real estate in hazardous areas (like those on undefended coasts), financial climate risk may manifest as an increase in illiquidity, as market participants reassess their desire to hold such assets.
Blurred Boundaries: How Risks Intersect
The planetary, economic, and financial systems do not operate in isolation to one another. They are tightly integrated, meaning investors would be unwise to neglect changes in the former two systems, even if a direct, immediate linkage to the financial system is not clear.
Indeed, it may be that the second-order, indirect impacts of climate-fuelled planetary and economic risks have the most material portfolio effects. For example, higher crop prices — caused by repeated bouts of extreme weather — directly affect commodity markets and the revenues of grocery businesses. However, indirectly they can also cause higher inflation and hence higher interest rates, affecting all financial assets.
It is also important to understand that the transmission of planetary and economic risks to the financial system may not be linear. What appear to be severe planetary and economic risks may not result in critical financial risks. And on the flipside, seemingly mild planetary and economic shocks could have outsized effects on certain portfolios.
Much depends on the exposure and vulnerability of specific markets and securities issuers, which can be dialed up or down by the actions of the public and private sectors. There are adaptive measures that governments may take to lessen the economic impact of planetary risks within their jurisdictions: for example, by investing in coastal flood defences and forest clearing to prevent wildfires. Individual companies can prepare for, and harden themselves against, planetary risks by drafting and implementing adaptation plans of their own.
Modelling the Full Cascade
Trex’s physical risk suite is built to address this challenge. We enable financial professionals to project how climate risks cascade through these three interconnected systems and translate the findings into decision-useful information.
We look at physical climate risk through a probabilistic lens, in order to capture low-likelihood but high-impact events — the sort that can take portfolio managers by surprise. Think of the recent Texas flash floods. Two factors contributing to their devastation were the intensity of the rainstorms that passed over the area and the drier-than-usual conditions on the ground. Such dynamics are likely to become more prevalent in a warmer world, and catalyse ever-greater incidents of economic and financial destruction. Our probabilistic approach allow us to evaluate a wide range of potential damages, including tail risks often ignored in deterministic models.
Moreover, we are among the few modelling platforms that explicitly account for climate tipping points in our analysis. While these first and foremost present long-term risks to the planetary system, as referenced above they also have implications for economic and financial performance over the near- and medium-term, severe enough to warrant inclusion in investment professionals’ risk assessments.
Conclusion
The planetary, economic, and financial systems should not be thought of as independent. In reality, they are closely integrated: meaning risks that manifest in one can propagate to the others in a non-linear fashion.
Modelling for this kind of risk transmission is challenging, and requires investors to embrace uncertainty and look ahead to the second-order effects of planetary and economic disruptions. A head-in-the-sand approach is no alternative, however, nor is a blithe belief that certain climate-related risks are not the concern of financial professionals.
After all, when these systems change, there is no safe harbour for the unprepared.