Pension funds try to come to grips with scariest global warming scenario

Pension funds are assessing climate tipping points as a major investment risk, warning irreversible global warming could trigger rapid asset repricing

By Alastair Marsh

  Institutional investors are trying to figure out what it would mean for their portfolios if continually rising temperatures trigger what JPMorgan Chase & Co. is calling “climate black swan risks.” 

The scenario is one that investors including Allianz Global Investors and Standard Life Plc say they’re taking increasingly seriously. 

It’s “something we really need to think about,” said Hetal Patel, head of sustainable investment research at Standard Life. The investor plans to do an “initial development” of its risk management around climate tipping points next year, he said. That will include running simulations across the firm’s £317 billion ($425 billion) portfolio to see how assets would be impacted. 

 

Any investors not thinking seriously about such risks by mid-2028 would “really be out of the mainstream,” Patel said. 

Climate tipping points are critical thresholds in the Earth’s interconnected natural systems including air, land, oceans and ice. JPMorgan’s “black swan” analogy reflects the fact that, though treated as a tail-risk, the impact of any single tipping point being breached would be “highly consequential.” 

Put simply, they’re “the most frightening part of climate change,” says Antoine Poincaré, director general of the Apave Climate School, which educates corporate executives on how to manage climate risks.  

Long regarded as an outlier scenario, tipping points are now making their way into portfolio analysis and even informing financial regulations. 

The shift comes as temperatures rise at a dangerous rate. The world briefly surpassed the critical 1.5C global warming threshold for the first time back in 2024. The temperature is now on track to rise by almost twice that level this century, a trajectory scientists have called catastrophic. 

“Funds are asking a very practical question: what climate tipping points mean for portfolios on real decision horizons – when markets might reprice, where exposures are concentrated, and how to plan when the science is uncertain but the consequences could be abrupt,” says Sarah Kapnick, JPMorgan’s global head of climate advisory and a former chief scientist at the US National Oceanic and Atmospheric Administration.  

For now, her analysis indicates that debt markets would be among the first to take a price hit, after illiquid real assets. Investors would be wise to regularly update their tail-risk analysis to take the latest science into account, Kapnick adds. The exercise is difficult for banks, however, given the time horizon under which they operate, though mortgage portfolios are a “notable” exposure for longer-term durations, she says.  

While not a tipping point as such, this year’s heat waves signal “a hotter baseline,” Kapnick said. And “when change accelerates, systems can be pushed toward thresholds faster than society and markets can adapt.”  

Investors “waiting too long to adapt could leave too little time to respond effectively,” she said. 

For institutional investors with long-term horizons like Standard Life, the question now is “how to protect asset values” from such risks, Patel said. 

Scientists have identified more than a dozen tipping points which, if breached, can result in abrupt, dangerous and irreversible damage. Once thresholds have been crossed, it may take years — and even decades — for the damage to play out. But it will be too late to reverse.  

Examples include coral reefs dying, the Amazon rainforest turning into savannah and the Greenland ice sheet sliding into an irreversible melt. 

In October, researchers at the University of Exeter said the world was facing a “new reality” after having hit its first tipping point, namely the “widespread dieback” of warm-water coral reefs.  

Among tipping points of particular concern to northern Europe is the Atlantic Meridional Overturning Circulation (AMOC), a system of interconnected ocean currents that transports warm water from the equator to northwestern Europe and allows for milder winter temperatures. A breakdown of AMOC would mean weather patterns as we know them today would be completely disrupted. 

The fallout might include much colder winters in the UK, for example, with more recent models indicating the potential for extreme cold spells that could drive the temperature to 20C below zero in London, and result in Arctic sea ice potentially reaching as far south as East Anglia, home to Cambridge University. At the same time, global warming is expected to continue driving hotter, drier summers, which would raise the risk of water shortages and lead to profound disruption to key sectors such as agriculture. 

Tim Lenton, a climate scientist at the University of Exeter renowned for his work on tipping points (including the scenario above), says the calculus among investors has changed in recent years.  

“The risk can take time to be fully realized,” Lenton said. “But if that change is underway and irreversible, you may choose to reprice now and bring the future into the present.” 

Financial watchdogs are taking note. In the UK, the Prudential Regulation Authority last year told banks and insurers to account for climate risks that may be non-linear and irreversible. The PRA also said that backward-looking data is no longer a reliable guide for the risks ahead. 

AllianzGI, which looks after €600 billion ($685 billion) in assets from its base in Frankfurt, Germany, is among investors figuring out how to adapt. Mark Wade, head of sustainability research and stewardship at AllianzGI, says it’s worth paying close attention to the insurance industry to gauge how soon asset prices will start to react. 

“It will be the insurability and financial tipping points that arise from the breach of climate and biodiversity tipping points that really garner mainstream attention,” he said.  

With the physical manifestations of climate change “already showing up,” Kapnick at JPMorgan says that investors now recognize “that nonlinear step-changes – and even policy-driven disclosure – can force repricing faster than traditional models assume.” 

But figuring out how to model such risks represents a gargantuan challenge for professional money managers. 

Mirko Cardinale, head of investment strategy at USS Investment Management Ltd., which oversees the pensions of the employees of Britain’s universities, says that “any attempt to really predict when a tipping point is going to occur is not going to be a very useful exercise.” 

However, “what we do know is that there is evidence that there are some tipping points, like the permafrost thawing, or even AMOC breakdown, that could tip in the next 15 to 20 years,” he said.  

For scenario analysis, USS generally focuses on a time horizon of five to 10 years, Cardinale said. By the end of that period, USS is alert to the potential for tipping points to become relevant, he said. 

Poincaré at the Apave Climate School says “it is possible that we will pass the point of no return this decade, but the real impacts might not be felt until 50 years from now.” 

The lack of progress in fighting climate change means that some investors are now bracing for extreme scenarios, says Justine Schafer, head of climate modeling at the £1.2 trillion asset management unit of Legal & General Group Plc.  

“There is a sense of some people losing hope that there is a change coming in terms of an energy transition,” she said. A slower pace of decarbonization than hoped is leaving some investors “wanting to prepare for the very, very worst outcome.”

For investors trying to grasp the implications of tipping points, part of the challenge is that they dwarf previous crises, according to Aniket Shah, global head of sustainability and transition strategy at Jefferies. 

“Economies and companies adapt to wars and to Covid, and that adaptation can happen quickly,” he said. “However, unlike wars and pandemics, the difference here will be that we have not seen irreversible shocks like this before.”