Policy risks are most likely associated with increased environmental standards. Here’s a detailed
explanation:
Definition of Transition Risks: Transition risks refer to the financial risks that result from the transition
to a lower-carbon economy. These can arise from policy changes, legal actions, technology
developments, and market shifts.
Policy Risks and Environmental Standards: Policy risks specifically relate to changes in regulations and
policies aimed at addressing climate change and environmental issues. Increased environmental
standards often involve stricter regulations on emissions, waste management, resource use, and
other environmental impacts.
Impact of Policy Risks: Companies may face increased costs of compliance, the need for new
investments to meet regulatory requirements, and potential fines or sanctions for non-compliance.
These policy changes can significantly affect business operations and financial performance.
Comparison with Other Risks:
Legal Risks: Legal risks involve litigation and legal actions related to environmental damages or
failure to comply with environmental laws. While related, they are distinct from policy risks, which
are driven by regulatory changes.
Technology Risks: Technology risks involve the adoption of new technologies and the potential for
current technologies to become obsolete. While technology plays a role in meeting increased
environmental standards, policy risks are more directly linked to regulatory changes.
CFA ESG Investing Reference:
The CFA Institute explains that policy risks are a significant component of transition risks, particularly
when governments implement stricter environmental standards to combat climate change (CFA
Institute, 2020).
Increased environmental standards often lead to policy risks as companies must adapt to new
regulatory landscapes, making it the most relevant type of transition risk in this context.
By understanding these risks and their implications, investors can better manage their portfolios in
the face of evolving environmental standards and regulatory changes.
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