Why Climate Tipping Points Belong in Scenario Analysis
Trex stands apart from other climate scenario data providers by modelling how systems evolve, and how the ripple effects of these changes unfold.
Foundational to our approach is the consideration of tipping points. These are thresholds that, if crossed, can trigger abrupt and irreversible changes to human and natural systems. While it may take only a small shift for a tipping point to be breached, once this happens self-propelling change becomes all but impossible to stop.
Tipping points can be positive or negative. In the climate context, negative tipping points are those that set off cascading environmental changes that accelerate the impacts of global warming – and sometimes accelerate the warming itself. Think the melting of permafrost or Amazon rainforest dieback, events that would release vast quantities of greenhouse gases and usher in a new age of weather extremes much sooner than expected.
Positive tipping points, on the other hand, are typically associated with human systems. These are the social and technological shifts that could speed our collective journey to a decarbonised economy and, in turn, to a less hazardous climate change outcome. As our Chief Scientific Advisor, Professor Tim Lenton, has argued, electric vehicle (EV) adoption may be nearing – or even past – just such a tipping point, making their future dominance of road transport an inevitability.
Positive and negative tipping points have profound implications for the structure of economies, markets, and social systems. Hence why it’s essential that investment professionals consider these thresholds in their forward-looking scenario analyses.
Read on to learn more about the importance of tipping points in investment risk analysis.
Why Tipping Points Matter In The Here And Now
Tipping points have the potential to completely disrupt the physical and market environments investors operate within. For example, if EV adoption “tips”, the business trajectories of all companies and suppliers locked into the internal combustion engine (ICE) paradigm are likely to degrade – and fast.
Planetary-scale tipping points could fundamentally reshape investors’ long-term outlooks, too. Trex is analysing two such tipping points: permafrost melt and the collapse of the Atlantic meridional overturning circulation (AMOC). The latter is a global “conveyor belt” that shifts warm and salty waters around the globe, helping to regulate the climate in the northern hemisphere and the monsoons in the tropics. Global warming threatens to slow this system, or even stop it entirely. As the world heats up, more freshwater ice is melting into the Atlantic, reducing the ocean’s salinity and putting the brakes on the current. If the AMOC collapses, the consequences could be world-changing. In the space of a few short decades, Europe and the UK would likely become dramatically colder and more susceptible to violent weather events.
While the fallout from tipping points could be monumental, the challenge for investors is one of timing. First, they have to be able to estimate when a certain point could be “tipped”, and second, approximate over what time horizons their effects will manifest.
Some tipping points could be reached within the medium- to long-term investment horizon (5-10 years). One recent estimate suggests the AMOC could start to collapse as early as the 2030s. Meanwhile, the Global Tipping Points report 2023 claims that tipping points for renewable electricity growth have already been crossed for many countries, and those for food systems and transport are getting close.
While it may take years – or decades – for the full consequences of tipping point breaches to unfold, it is highly likely that some impacts will crystalise in the near future. For example, within the next decade, markets could abruptly reprice equities linked to the ICE automobile industry in recognition of the irreversible advance of EVs. Credit rating agencies and fixed income investors may downgrade the creditworthiness of “dirty” agrifood businesses, while real asset investors could rotate capital into European utilities and infrastructure in anticipation of a colder, more volatile climate following a potential AMOC collapse.
Effects like these are why even those tipping points that have “tails” extending centuries should be considered by investors.
Why Investors Struggle to Price Tipping Points
Timing is one challenge when it comes to modelling tipping points. Estimating the cascading effects is another.
Here’s an example. Amazon forest dieback is likely to lead to the transformation of rainforest ecosystems into savannah and widespread drying. This in turn would expose millions in South America to extreme heat stress, undermine food security across the continent, increase the prevalence of wildfires, and exhaust valuable ecosystem services.
Quite how these vast changes to the environment would cascade through economic and financial systems is difficult to gauge. Over time, the transformation of the Amazon could chip away at the sovereign creditworthiness of South American countries and undermine the stability of agribusinesses reliant on the ecosystem services provided by the rainforest. But just how severe these impacts could be depends on a multiplicity of factors, including the adaptive actions of governments and ability of affected businesses to move assets, operations, and supply chains.
Accounting for the many variables that could attenuate – or augment – the consequences of tipping points for financial markets is beyond the scope of most traditional climate risk modelling approaches, and helps explain why these are rarely factored into forward-looking scenario analyses.
What Regulators & Institutions Want
These challenges notwithstanding, financial regulators and the institutions they oversee are clamouring for tipping points to be incorporated in climate risk assessments.
In its latest climate report, Natwest Cushon, a UK workplace pensions provider, said it was concerned that tipping points could “cause a material repricing in global markets.” The company is now partnering with Trex to model the potential impacts. Another Trex partner, Universities Superannuation Scheme (USS), says it incorporates “tipping point modifiers” in its short-term assessments to capture how these could lead to “potential risk changes.”
In the UK, the Prudential Regulation Authority (PRA) – the country’s regulator of financial institutions – recognises that tipping points are a current blindspot in climate risk analysis. A recent consultation paper issued by the watchdog, CP10/25 – Enhancing banks’ and insurers’ approaches to managing climate-related risks, notes that “standard stress testing and scenario analysis approaches calibrated on backward looking data are not suitable predictors of climate-related risk”, in part because they cannot capture “non-linearities, potential for tipping points and irreversible damage.” Several responses to this consultation also underlined the centrality of tipping points to a holistic appreciation of climate risks.
The direction of travel is clear: as institutions and regulators refine their approaches to climate scenario analysis, they are increasingly recognising the critical role of tipping points.
The Trex Approach
At Trex, we are developing scenario approaches that account for tipping dynamics and how they propagate shocks across the financial system. As a first step, we are developing probabilistic modelling of two potentially near-term tipping points: permafrost thawing and AMOC collapse.
Our approach is built on the following foundations:
Science-led baselines: Climate scenarios built around realistic physical narratives that explicitly consider the likelihood of tipping events, rather than assuming a smooth rise in damages.
Probabilistic framing: We model ranges of outcomes, including low-probability, high-impact pathways, rather than deterministic averages.
Systemic interconnections: We map not only direct losses, but contagion through supply chains, insurance markets, and sovereign exposures.
Positive tipping points: We include upside dynamics, like EV adoption and renewable energy take-off, that can rapidly accelerate transition pathways.
While our approach is not about forecasting the exact year tipping points are crossed, or the precise timelines over which their consequences ripple around the world, it is capable of stress-testing portfolios against the possibility such ruptures could occur, and estimating how capital allocation strategies would hold up if they did.
In this way, Trex is able to offer a more complete view of climate risks, enabling financial institutions to stay abreast of real-world systems change.
