Climate tipping points threaten the global economy and financial system

The Earth is getting hotter: global warming is now on track to reach around 2.7 degrees Celsius by the end of the century – well above the Paris climate targets of 1.5 to 2 degrees. “The massive impact of climate change on all areas of life is still underestimated – as are the impending consequences for financial systems and capital markets,” says Dr. Heinz-Werner Rapp, founder and director of the FERI Cognitive Finance Institute. The main reason for this is that the enormous significance of key tipping points in the global climate system is often not taken into account at all or not sufficiently. The FERI Cognitive Finance Institute analyzes their current dynamics and the foreseeable consequences for the environment, economy, society, and financial system in its new comprehensive study “Climate Tipping Points – The tipping of essential climate systems as a global risk.”

Progressive tipping dynamics in the global climate system

Tipping elements are fundamental subsystems of the Earth's climate that, when critical temperature thresholds are exceeded, irreversibly and often relatively quickly transition to a new state. The most important tipping elements include the ice sheets in Greenland and Antarctica, the Atlantic Ocean circulation, and the Amazon rainforest. “Basically, once the respective tipping point is exceeded, a very dynamic, nonlinear, and self-accelerating process begins—a vicious circle,” explains Rapp. 

In addition, many climate tipping elements are interconnected in complex ways. For example, polar ice melt not only leads to sea level rise, but also intensifies global warming and at the same time causes a weakening of the Atlantic circulation – effects that in turn influence other tipping elements and can accelerate their tipping dynamics. “This is the central problem: the overall effect of such domino effects and self-reinforcing tipping cascades creates far greater climate risks than many climate models have assumed to date,” emphasizes Rapp. 

According to climate researcher Nico Wunderling, professor of Earth system science at the Center for Critical Computational Studies at Goethe University Frankfurt, there is a risk that important climate tipping points will soon be reached or exceeded. This would pose serious risks to planetary ecosystems and to the nutrition and well-being of billions of people. However, the economic costs of climate change are also rising rapidly, requiring ever greater resources worldwide and putting existing provision and protection systems under enormous pressure. 

Underestimated risks with exponential growth

“Global capital markets have clearly underestimated the risks of climate tipping points up to now. Recently, however, major insurance companies have been issuing alarming statements that have sent shock waves through the financial system,” explains Rapp. Many individual risks are hardly insurable anymore in light of catastrophic climate damage, which could quickly turn into a systemic problem: “Residential buildings, factory buildings, or port facilities that no longer receive insurance coverage for climate-related damage but are simultaneously burdened with high mortgages become an unacceptable risk from the lenders' perspective,” warns Rapp. Banks would then have to make value adjustments on loans and set aside provisions for impending loan defaults. “If such requirements occur frequently and in a concentrated manner, which is very likely in the event of sudden climate change, the entire banking and credit system will suddenly face an acute problem.”

Enhanced risk assessment and repricing of risk

In parts of the global financial system, this is already leading to significantly changed risk assessments: “The first supervisory and regulatory authorities, including Germany's BaFin and the ECB, are calling for stricter standards for recording physical climate risks,” Rapp explains. Internationally, new risk metrics are being developed in line with “planetary solvency” – with the aim of more realistically recording impending climate risks and systemic consequences. “As our analysis shows, the risk profile of global climate change increases exponentially as soon as the principle of climate tipping points is adequately taken into account,” explains Rapp. However, this aspect has so far been significantly underestimated or not sufficiently acknowledged in many discourses. “As soon as this changes under the pressure of reality, there is a risk of an abrupt reassessment of climate risks – including on the capital markets,” warns Rapp. Entrepreneurs and investors are called upon to familiarize themselves quickly and consistently with this complex topic. 

The study “Climate Tipping Points – The collapse of essential climate systems as a global risk” by the Bad Homburg think tank of the FERI Group provides investors and entrepreneurs with in-depth insights into the underlying issues and supports them in analyzing and evaluating future challenges. The short version of the study, in which Prof. Nico Wunderling was involved as an external consultant, is available in German for download on this page.