Extending the lens on climate change to capital market assumptions: Asia-Pacific

Including climate change considerations in CMAs alone is insufficient to adequately address climate risk

Creates inconsistences with bottom-up analysis

Incorporating risks from scenarios such as the NGFS's pathways into CMAs to estimate the impact of climate change on economic growth, potentially underestimates physical risks. The mix of transition and physical creating inconsistencies with bottom-up analyses and stress-testing exercises that seek to identify and quantify climate risks within investment portfolios.

Overlooks broader climate-related disruption

While including climate into CMAs is a useful starting point, many organisations found that the resulting changes to expected returns were relatively modest and often failed to reflect the systemic nature of climate change. Traditional models overlooking broader disruptions such as supply chain breakdowns, reduced productivity, resource scarcity, migration and economic and social instability. This has been observed particularly as a disconnect between the climate risks identified through a qualitative narrative, such as a high warming scenario, and the limited impact shown in quantitative modelling.

Does not drive material changes to strategic asset allocations

Climate-adjusted CMAs, on their own, may not materially alter strategic asset allocation under traditional asset-class frameworks that rely on mean-reverting, historical assumptions. Averages of future climate impacts are insufficient to provide insights on the range of possible outcomes and impacts on asset returns and risk profiles.

Climate scenario analysis is an invaluable complement to climate-adjusted CMAs

Recognising these limitations, many organisations have come to view climate scenario analysis as an essential complement to climate-adjusted CMAs, representing a key step towards addressing climate risk more comprehensively. Beyond informing expected return assumptions, it connects insights across asset classes, investment teams, and risk functions, fostering a more integrated understanding of climate-related risks and opportunities. This holistic view helps organisations consider not only how portfolios may perform under different climate pathways, but also the role they can play in shaping a more resilient future.

Practical application in recent years include:

• The ability to stress-test portfolios under a range of plausible climate futures and use the resulting insights alongside the expected return assumptions embedded in capital market assumptions
• Allows investment teams and boards to shift the focus from a single central forecast to a broader assessment of long-term climate-related risks
• Quantifies the potentially much higher costs of climate inaction, enabling asset owners to communicate the financial implications of delayed transition, worsening physical risks, and broader economic disruption to boards and other stakeholders
• Provides greater visibility of long-term risks over the retirement horizon of superannuation members (pension fund beneficiaries), illustrating how portfolio outcomes may deteriorate in a high-warming future and supporting evidence-based climate policy advocacy that promotes a more resilient economy and, ultimately, stronger retirement outcomes for members
• Assesses the resilience of existing strategic asset allocations across a range of plausible climate futures, helping identify where adjustments may be warranted and informing benchmark design, manager selection, and security- and asset-level investment decisions across both public and private markets.

Relaxing mean reversion assumptions in CMAs: a further step towards addressing climate change

Traditional asset allocation approaches often rely on mean reversion, assuming that historical market relationships will persist over time. However, climate change challenges this assumption, as future economic and market conditions may differ materially from the past. Relaxing reliance on historical averages and incorporating more forward-looking assumptions can help investors better capture the potential impact of climate-related risks on future portfolio outcomes.

Use climate scenarios to understand the impact of climate change to liabilities and business continuity

Beyond investment portfolios, climate scenarios also support broader strategic decision-making by helping organisations understand which future environments they are best positioned to operate in under a whole-of-business context, such as the ability to offer insurance policies and meet payouts. They can also be applied to operational resilience, including testing whether business operations can continue to support customers under more extreme physical climate risks.

Integrating ‘uneven’ climate risk into asset management frameworks using CMAs and climate scenarios

From an asset manager's perspective, the focus is on supporting clients through the climate transition while managing its implications for investment funds, recognizing that climate-related risks are increasingly important drivers of investment outcomes, affecting both expected returns and market uncertainty.

As climate impacts are not evenly distributed globally, this creates greater dispersion in outcomes across regions, sectors, and securities. Climate-adjusted CMAs and scenario analysis therefore provide a valuable framework for exploring these different pathways, facilitating discussions with clients about the likelihood of various outcomes, their associated risks, and their potential portfolio implications. However, a number of challenges remain at the forefront:

Translation of high-level macroeconomic impacts into company-level insights

While climate scenarios may estimate effects on GDP, these do not always align directly with the financial performance of individual businesses. As a result, one of the biggest challenges is developing data and analytical approaches that make climate scenarios both practical and actionable for portfolio managers and asset allocators. Climate scenarios are valuable for setting the strategic landscape and framing investment risks, but converting them into specific investment actions at the company level requires more granular analysis and robust data.

Effective selection and quantification of scenarios for climate stress-testing

As climate pathways continue to evolve, investors must carefully select scenarios that provide appropriate and credible risk assessments for climate stress testing. This requires evaluating whether scenarios realistically capture both transition and physical risks, while also incorporating emerging new risks such as changes in insurance availability and increasing exposure to climate hazards. Consequently, identifying reliable data sources and scientifically credible reference scenarios is essential for supporting informed investment decisions.

Using climate scenarios effectively: Interpretation, application, and limitations

From an investor’s perspective, climate scenarios should be applied with careful consideration of their purpose, assumptions, and limitations. For example, the NGFS scenarios were developed primarily to assess financial stability implications of the transition over shorter time horizons. As a result, they may not fully capture the longer-term costs of climate inaction or may produce quantified outputs that require further interpretation when they appear inconsistent with scientific evidence or investment judgement.

Investors are encouraged to understand the underlying narratives and limitations behind each scenario and adjust their interpretation accordingly, rather than relying solely on headline numbers. While no scenario is perfect, understanding their assumptions and limitations enables investors to use them as decision-support tools rather than precise forecasts. This is critical as delayed climate action may not reduce transition risks, but instead defer and magnify them, increasing the likelihood of more costly and disorderly transitions that test portfolio resilience and heighten physical risks over time.

Other widespread market shocks, risks and uncertainty

Investors should recognize that many climate scenarios assume relatively smooth market adjustments, and be cautious to not overlook that real-world climate impacts may occur through sudden shocks, supply chain disruptions, policy shifts, or market repricing events.

Market pricing

Market repricing is a critical third dimension of climate risk alongside physical and transition risks, reflecting the possibility that changing policies and risk perceptions could lead to rapid valuation adjustments. Climate scenarios help to identify these ‘embedded’ risks at asset class level, which can differ significantly across scenarios and geographies, and can be counterintuitive to many investment teams. These insights support deeper portfolio construction discussions, helping investors reassess exposures, challenge assumptions about diversification and defensive assets such as fixed income portfolios, and better understand how climate risks may influence the role different asset classes play within a portfolio.

Supply chain disruptions

Scenarios may not fully capture the cascading effects of climate-related disruptions, particularly where critical inputs, limited substitutability, and concentrated supply chains increase vulnerability. While models may account for supplier networks, they often do not fully capture the importance of specific inputs or the extent to which disruptions can propagate through complex systems.

As a result, relatively small disruptions can have disproportionate impacts across industries, meaning top-down climate scenarios may underestimate contingent risks and may not provide sufficient resolution to translate macroeconomic impacts into company- or portfolio-level investment decisions.

Policy fragmentation and transition uncertainty

Climate policy responses are becoming increasingly uneven across regions, creating additional transition risks for investors. Variations in regulatory ambition, policy implementation, and market responses mean that the impacts of climate transition are unlikely to be uniform, with volatility potentially emerging both across regions and over time.

These policy-driven shifts can lead to significant differences in economic outcomes, including GDP growth and inflation, while remaining challenging to model precisely. This highlights the importance of climate scenario analysis as a tool for exploring a range of possible pathways rather than predicting a single future. Framing scenarios as narratives helps investors better understand the uncertainty and variability associated with different transition trajectories.

Assessing overall climate resilience under a changing investment landscape

Predicting the exact shape of future portfolios is inherently challenging, as asset allocations will evolve over time in response to market performance, investment decisions, and new opportunities. However, applying scenarios to a static portfolio provides a useful way to identify potential vulnerabilities and areas of focus. Rather than forecasting the future portfolio, this approach helps investors identify potential areas of risk, highlight companies or sectors requiring engagement, and determine where transition finance or additional support may be needed.

Taking a broader organisational perspective is also important, as climate change may affect not only investment portfolios but also members, stakeholders, business operations, and future liabilities. Considering these multiple lenses helps asset owners develop a more complete understanding of climate risks and opportunities over the long term.

Panelist overview

The perspectives summarized above are based on input from the following panelists who participated in our ‘Virtual panel discussion #2 (Asia-Pacific): Extending the lens on climate change to capital market assumptions’ that took place on Wednesday July 29 under Chatham House Rule.