Understanding Transition Risk: A GARP SCR Deep Dive

Kateryna Myrko
Jul 29
5 min read

In the Global Association of Risk Professionals’ (GARP) Sustainability & Climate Risk (SCR®) Certificate, transition risk is defined as the financial risk that arises from the process of adjusting towards a lower-carbon economy. Understanding transition risk—and its drivers, transmission channels, and modeling techniques—is essential for risk professionals preparing for the 2025 SCR exam. This deep-dive articulates the latest, trustable insights into transition risk, drawing on the Task Force on Climate-related Financial Disclosures (TCFD) framework, financial-firm practice surveys, and leading quantitative models. GARP SCR , Understanding Transition Risk

1. Defining Transition Risk GARP SCR , Understanding Transition Risk

Transition risk comprises the potential financial losses and opportunities that firms face as economies shift away from high-carbon activities toward net-zero emissions. The TCFD splits climate-related financial risks into two categories—physical and transition risks—and defines transition risks as those stemming from policy, legal, technological, market, and reputational changes associated with decarbonization.

Key characteristics:

Path-dependence: The timing and sequencing of policy actions, technological adoption, and market shifts fundamentally shape the magnitude of transition impacts.
Sector and firm heterogeneity: Carbon-intensive industries (e.g., oil & gas, utilities) and their counterparties (e.g., banks, insurers) bear the most acute risks.
Financial transmission: Losses propagate through credit, market, liquidity, and operational risk channels as assets become stranded or devalued.

2. The Four Drivers of Transition Risk

The TCFD’s 2017 recommendations identify four principal drivers of transition risk, each carrying distinct financial and strategic implications:

Policy & Legal Risks
- Carbon pricing (taxes, cap-and-trade): Increases operating costs for emissions-intensive firms.
- Regulatory mandates (renewable targets, disclosure requirements): Force capital reallocation and compliance expenditures.
- Litigation risk: Growing climate-related lawsuits against firms and directors for inadequate risk management or “greenwashing.”
Technology Risks
- Innovation disruption: Emergence of low-carbon alternatives (e.g., renewable energy, battery storage) can render legacy assets uneconomic.
- Adoption uncertainty: The pace and success of deploying new technologies (e.g., hydrogen, carbon capture) affect transition costs.
Market Risks
- Supply-demand shifts: Changes in consumer preferences and input costs (e.g., higher oil vs. lower renewable prices) impact revenue streams.
- Asset revaluation: Rapid repricing of carbon-intensive assets can trigger market losses and liquidity strains.
Reputation & Stakeholder Sentiment
- Consumer preferences: Rising demand for sustainable products pressures “laggard” firms.
- Investor scrutiny: ESG-focused capital flows and engagement campaigns can penalize poorly positioned companies.

Understanding these interconnected drivers enables SCR candidates to map transition risk exposures across industries and portfolios.

3. Transmission Channels & Scenario Analysis

Because empirical data on transition impacts remain limited, firms rely heavily on scenario analysis to explore potential outcomes under different transition pathways.

Orderly vs. disorderly transitions:
- Orderly—gradual policy implementation, predictable technology adoption, smooth market adjustments.
- Disorderly—late or abrupt policy shifts, technology catch-up lags, sudden market repricing.
NGFS Scenarios: The Network for Greening the Financial System’s Disorderly and Orderly pathways are the most widely used among banks and insurers.
Scenario selection: Firms align scenario narratives (e.g., SSP1-2.6, SSP3-4.5) with economic variables—GDP growth, carbon prices, unemployment—to quantify balance-sheet impacts.

By embedding scenario outputs into credit models, market-risk VaR frameworks, and ICAAP stress tests, risk managers can estimate capital needs under a range of transition outcomes.

4. Quantitative Modeling: Transition-Risk Climate VaR

A leading example of transition-risk quantification is MSCI’s Transition-Risk Climate VaR model, which simulates asset-level valuation shocks under NGFS scenarios and aggregates them into portfolio-level Value-at-Risk. Key findings:

Scope 1 emissions (direct) are typically the strongest driver of simulated losses, reflecting the immediate impact of carbon pricing on high-emitting firms.
Scope 3 emissions (value-chain) also contribute significantly once deduplicated correctly, underscoring the need for comprehensive emissions data.
Scenario enhancements (e.g., updated NGFS inputs) improved model explanatory power (R²) from ~73% to ~80% between 2021 and 2023.

Such frameworks illustrate how transition risks can be integrated into market-risk processes, complementing traditional risk measures.

5. Transition-Risk Management & Mitigation

Risk professionals must design holistic strategies to mitigate transition exposures across the enterprise:

Policy engagement: Advocate for predictable, phased regulatory frameworks to reduce disorderly shock potential.
Technology investment: Finance and deploy low-carbon solutions (renewables, energy efficiency, carbon capture) to diversify asset risk.
Portfolio alignment: Use exclusion, tilt, and engagement strategies to reduce carbon intensity and improve climate resilience.
Counterparty risk management: Incorporate transition metrics (e.g., TPI scores) into credit underwriting and collateral valuation.
Disclosure & transparency: Align with evolving standards—TCFD, IFRS S2, EU CSRD—to ensure robust, comparable reporting of transition plans and metrics.

Building these capabilities is central to the GARP SCR curriculum and a central focus of advanced exam questions.

6. Evolving Regulatory Landscape

Since issuing its recommendations in 2017, the TCFD has catalyzed mandatory frameworks worldwide:

IFRS S2 (effective 1 Jan 2024) integrates TCFD’s four pillars—governance, strategy, risk management, metrics & targets—and mandates disclosure of transition-risk strategies and scenario analyses.
EU CSRD/ESRS requires double-materiality reporting, embedding transition-risk disclosures into corporate sustainability statements.
U.S. SEC continues rulemaking on climate filings, with ongoing litigation shaping Scope 1/2/3 emission requirements.

SCR candidates should stay abreast of these developments to anticipate exam scenarios on disclosure requirements.

7. Exam-Ready Insights

To excel in the GARP SCR exam’s transition-risk module, candidates should be able to:

Define transition risk and differentiate it from physical risk.
List and explain the four TCFD drivers, with examples of financial impacts.
Describe scenario analysis steps, including scenario selection (NGFS, SSP/RCP), variable mapping, and stress-testing integration.
Interpret key outputs from quantitative models like MSCI’s Climate VaR—identifying top emissions drivers and understanding model enhancements.
Articulate transition-risk management practices, from policy engagement to portfolio alignment.
Compare major disclosure regimes (TCFD, IFRS S2, CSRD) regarding transition-risk requirements.

Structuring answers around these domains, with clear definitions, frameworks, and recent data points, will demonstrate a comprehensive mastery of transition risk.

Transition risk sits at the nexus of climate science, economics, and financial risk management. By understanding its drivers (policy, technology, market, reputation), transmission channels, modeling approaches, and regulatory demands, GARP SCR candidates equip themselves to navigate—and help shape—the low-carbon transition. Mastery of these concepts not only supports exam success but also prepares risk professionals to safeguard portfolios and institutions against the evolving landscape of climate-related financial risks.

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