Climate change poses a systemic financial risk that cannot be avoided by portfolio decarbonisation alone, Universities Superannuation Scheme Investment Management (USSIM) has warned, urging governments and asset owners to adopt stronger, sector-wide transition policies.

In a new paper, The Policy Challenges of the Energy Transition, produced with support from Transition Risk Exeter (Trex), USSIM argued that climate change has become a present-day financial threat that could undermine the stability of the global investment system on which pension funds rely.

The paper highlighted that many climate risks are non-linear, meaning that seemingly small shifts in environmental conditions can drive sudden, disproportionate financial losses.

It cited examples such as the additional $8bn in damages caused during Hurricane Sandy due to just 10cm of sea-level rise, and noted that extreme heat events - once considered remote risks - are now far more frequent, with the UK over twenty times more likely to experience temperatures above 40°C than in the 1960s.

Such shifts, USSIM warned, challenge the models pension funds traditionally use to assess long-term return expectations and threaten the stability of entire financial systems.

The organisation emphasised that reducing emissions within portfolios does not “meaningfully mitigate” the real-world climate risks that ultimately matter for funding security.

Divesting carbon-intensive assets, it said, also “does nothing” to lower systemic exposure and may even push risks elsewhere in the market.

Instead, the paper argued that asset owners must adopt more sophisticated climate and transition risk analysis and deepen collaboration with policymakers to help shape the broader economic environment in which pension returns are generated.

Physical climate risks are already included in country-level assessments, with work underway to integrate transition and physical risk factors across public and private markets.

USSIM stressed that this is vital for maintaining a resilient, diversified portfolio capable of delivering stable returns through climate-driven volatility.

The study also warned that the transition itself carries material risks for pension investors.

Citing analysis undertaken with Trex and UKSIF, the paper noted that more than $2trn of global oil and gas asset value could be wiped out by 2040 even if governments simply meet existing climate pledges, with UK investors disproportionately exposed to around $140bn of that risk due to holdings in overseas fossil fuel assets.

Such potential losses, it said, underline the need for asset owners to anticipate non-linear transition dynamics, including rapid declines in the profitability of carbon-intensive sectors once clean technologies reach critical market-share thresholds.

However, USSIM argued the transition is also a “major economic opportunity” for pension funds.

Modelling cited in the paper suggests a fast and orderly shift to clean technologies could save the global economy around $12trn in energy costs by 2050 relative to a no-transition pathway, with significant benefits for net-importing countries like the UK.

With the right policy framework, the organisation believes the transition could catalyse over £25bn a year of domestic investment, supporting productivity, innovation and more resilient long-term returns for pension schemes.

Despite the UK being the first major economy to halve its emissions, USSIM warned that progress has been concentrated almost entirely in electricity generation, with heating, transport, heavy industry and aviation still far off track.

The organisation said government action is now “essential” to unlock investment and manage transition risks, arguing that each sector of the economy requires tailored, stage-appropriate policy support.

USSIM concluded that the pace and scale of global change leave “no time to lose”, warning that climate tipping points and accelerating transition dynamics represent risks that cannot be diversified away.

It added that a well-managed transition could deliver long-term financial benefits, including reduced volatility and stronger real returns, but stressed that this depends on governments adopting comprehensive, long-term policy programmes that support the deployment of clean technologies across all sectors.

Without this, the paper argued, pension funds will face an increasingly unstable
investment environment that threatens their ability to meet future obligations.

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