Interview: practitioners on Risk management & portfolio construction — what they wish they knew earlier

According to the European Central Bank's 2024 climate stress test, approximately 70% of European banks' corporate loan portfolios remain exposed to transition risks, with potential losses ranging from €70 billion to €180 billion under disorderly transition scenarios. These figures represent not abstract projections but tangible threats to institutional balance sheets—a reality that portfolio managers and risk officers across the EU are now confronting with increasing urgency. In conversations with practitioners managing climate-integrated portfolios across Frankfurt, Amsterdam, Paris, and Stockholm, a consistent theme emerges: the gap between theoretical frameworks and operational implementation remains the central challenge of sustainable finance in 2025.

Why It Matters

The integration of climate risk into portfolio construction has transitioned from a voluntary ESG consideration to a regulatory imperative across European markets. The EU Sustainable Finance Disclosure Regulation (SFDR), now in its mature implementation phase, requires asset managers to classify funds under Articles 6, 8, or 9, with Article 9 products demanding demonstrable sustainable investment objectives. As of Q4 2024, Article 8 and 9 funds collectively represent €5.8 trillion in assets under management across European domiciles, according to Morningstar data—a 340% increase from pre-SFDR levels.

The significance extends beyond regulatory compliance. The European Insurance and Occupational Pensions Authority (EIOPA) reported in 2024 that insurers holding concentrated fossil fuel exposures experienced 23% higher capital volatility compared to diversified sustainable portfolios. Meanwhile, the Network for Greening the Financial System (NGFS) scenarios, now adopted by 134 central banks globally, project that delayed transition pathways could impose GDP losses of 10-15% in carbon-intensive economies by 2050.

For portfolio construction professionals, the practical implication is clear: climate risk is financial risk, and the methodologies for quantifying, pricing, and managing this risk are still evolving. The European Banking Authority's 2025 guidelines on ESG risk management now mandate explicit integration of physical and transition risks into Internal Capital Adequacy Assessment Processes (ICAAP), creating accountability structures that reach from trading desks to board rooms.

"What changed fundamentally between 2022 and 2025," notes a senior portfolio manager at a major Dutch pension fund, "is that we moved from asking 'should we consider climate?' to 'how do we operationalize climate across every asset class?' The regulatory push was necessary, but the real driver was the repricing we saw in energy markets and the stranded asset write-downs in our real estate book."

Key Concepts

Risk Management in Sustainable Finance: Contemporary risk management extends traditional Value-at-Risk (VaR) and Expected Shortfall metrics to incorporate climate-specific factors. This includes Climate Value-at-Risk (CVaR), which models portfolio sensitivity to transition scenarios, and physical risk metrics that assess exposure to acute events (floods, wildfires) and chronic shifts (sea-level rise, temperature increases). Best practice now involves running portfolios through multiple NGFS scenarios—orderly transition, disorderly transition, and hot house world—to stress-test resilience across probability-weighted pathways.

Macro Environment and Interest Rate Dynamics: The European macro environment significantly influences sustainable portfolio construction. The ECB's green monetary policy framework, including preferential treatment for sustainable bonds in collateral frameworks, creates asymmetric opportunities. Interest rate sensitivity differs markedly between green and conventional instruments; empirical research from 2024 demonstrates that green bonds exhibit 15-20 basis points lower duration risk due to their investor base composition—predominantly buy-and-hold institutional investors with lower redemption volatility.

Standards and Taxonomies: The EU Taxonomy Regulation establishes the classification system for environmentally sustainable activities, with technical screening criteria now covering all six environmental objectives. Taxonomy-alignment serves as the primary KPI for Article 9 funds, with leading performers achieving 80%+ alignment in equity portfolios and 60%+ in fixed income. The Corporate Sustainability Reporting Directive (CSRD), mandatory for large companies from 2024, is dramatically improving data availability for taxonomy assessments.

OPEX Considerations in Sustainable Transitions: Operating expenditure analysis has become central to identifying genuine transition leaders versus laggards. Companies demonstrating elevated green OPEX ratios—research and development spending on clean technologies, workforce retraining costs, and circular economy initiatives—tend to exhibit more credible transition pathways. Practitioners report that OPEX analysis provides earlier signals of transition commitment than capital expenditure announcements, which may lag strategic pivots by 18-24 months.

Energy Transition Pathways: Portfolio construction now requires explicit assumptions about energy transition timing and mechanisms. The EU's REPowerEU plan and Fit for 55 package establish binding targets—55% emissions reduction by 2030, climate neutrality by 2050—that create both sectoral tailwinds (renewable energy, efficiency technologies, green hydrogen) and headwinds (unabated fossil fuels, carbon-intensive manufacturing). Practitioners increasingly use implied temperature rise (ITR) metrics to assess portfolio alignment with 1.5°C or 2°C pathways.

What's Working and What Isn't

What's Working

Scenario-Based Stress Testing with Quantified Outputs: Leading institutions have moved beyond qualitative climate risk assessments to fully quantified scenario analysis. ABN AMRO's implementation of NGFS-aligned stress testing across its €285 billion balance sheet provides granular sector-by-sector CVaR estimates, enabling proactive engagement with high-risk counterparties. The bank reports that this methodology identified €4.2 billion in exposures requiring enhanced monitoring or restructuring—insights that would have remained invisible under traditional credit risk frameworks.

Engagement-Linked Investment Mandates: Several Nordic pension funds, including Sweden's AP7 and Finland's Varma, have pioneered engagement-linked mandates that tie manager compensation to measurable decarbonization outcomes. These structures move beyond simple exclusion strategies to incentivize active ownership. AP7 reports that portfolio companies subject to structured engagement reduced weighted average carbon intensity by 28% between 2021 and 2024, compared to 11% for non-engaged comparators.

Physical Risk Integration in Real Assets: Real estate and infrastructure portfolios in the Netherlands and Germany now routinely incorporate physical risk scoring at the asset level. APG Asset Management, managing over €600 billion including substantial real estate allocations, has implemented flood risk overlays for Dutch property holdings, adjusting valuations and insurance requirements based on granular hydrological modeling. Properties in high-risk zones face 8-15% valuation haircuts, reflecting actuarial-adjusted replacement costs and potential obsolescence.

Transition Finance Frameworks for Hard-to-Abate Sectors: The European market has developed sophisticated transition finance instruments that enable investment in carbon-intensive sectors conditional on credible decarbonization pathways. The EU Green Bond Standard, finalized in 2024, includes provisions for transition bonds that finance taxonomy-aligned activities within otherwise brown companies. This approach avoids the perverse incentive of forcing divestment from sectors essential to the transition, such as steel and cement, while maintaining accountability through use-of-proceeds tracking.

What Isn't Working

Data Gaps in Scope 3 Emissions: Despite CSRD implementation, Scope 3 emissions data remains the critical weakness in portfolio carbon accounting. Practitioners report that >60% of Scope 3 figures in corporate disclosures rely on industry averages rather than actual supply chain measurement. This uncertainty propagates through portfolio carbon footprinting, rendering precise tracking of financed emissions unreliable. "We can tell you our Scope 1 and 2 exposure with reasonable confidence," admits a sustainability head at a French asset manager, "but our Scope 3 numbers have error bars larger than some of our actual holdings."

Taxonomy Usability Challenges: While the EU Taxonomy provides conceptual clarity, operational implementation remains burdensome. The technical screening criteria require detailed activity-level assessments that many companies—particularly SMEs—cannot provide. This creates a "green data divide" where large-cap companies achieve taxonomy alignment recognition while smaller firms, potentially with equivalent sustainability performance, remain unclassified. Asset managers report spending 3-5x more analyst hours on taxonomy assessment compared to traditional fundamental analysis.

Greenwashing Risks in Transition Labeling: The lack of standardized definitions for "transition" investments has created vulnerability to greenwashing allegations. Several EU-domiciled funds have faced regulatory scrutiny for classifying fossil fuel exposures as transition investments based on aspirational rather than binding company commitments. The absence of minimum safeguards equivalent to taxonomy "do no significant harm" criteria for transition instruments remains a structural gap that undermines market integrity.

Short-Term Performance Pressures: Quarterly reporting cycles and benchmark-relative performance measurement create friction with long-term climate risk management. Practitioners note that underweight positions in fossil fuels generated significant tracking error during the 2022 energy crisis, prompting client redemptions despite the structural thesis remaining intact. "We had the right view on a 10-year horizon," reflects a London-based portfolio manager, "but some of our clients couldn't tolerate being wrong for 18 months."

Key Players

Established Leaders

BlackRock: The world's largest asset manager has integrated climate risk across its Aladdin platform, providing clients with scenario analysis tools and portfolio-level CVaR metrics. Their EU-domiciled sustainable funds exceed €150 billion in AUM.

Amundi: Europe's largest asset manager by AUM manages over €2 trillion and has committed to net-zero alignment across all portfolios by 2050, with interim 2030 targets covering 90% of corporate holdings.

APG Asset Management: Managing €600 billion for Dutch pension funds, APG has pioneered responsible investment integration including physical risk modeling and real asset sustainability scoring.

Allianz Global Investors: With €500 billion in sustainable strategies, Allianz has developed proprietary climate transition assessment frameworks and offers one of Europe's broadest ranges of Article 9 products.

Nordea Asset Management: A Nordic leader in sustainable investing, Nordea manages €250 billion with comprehensive ESG integration and has achieved recognition for transparent carbon footprinting methodologies.

Emerging Startups

Clarity AI: This Madrid-based sustainability technology firm provides machine learning-powered sustainability analytics to over 150 institutional clients, specializing in taxonomy alignment and impact measurement.

Util: A London-headquartered fintech that maps company revenues to UN Sustainable Development Goals, enabling portfolio-level SDG alignment assessment with granular activity-level precision.

Carbon4 Finance: Spun out of Carbone 4 consultancy, this Paris-based firm provides climate risk analytics including physical and transition risk scoring for fixed income and equity portfolios.

Persefoni: While US-headquartered, Persefoni has substantial EU operations providing carbon accounting software that enables SFDR-compliant carbon footprinting at portfolio and product levels.

Rho Motion: A UK climate analytics firm specializing in energy transition data, providing granular forecasting on EV adoption, battery supply chains, and renewable deployment that informs sector allocation decisions.

Key Investors & Funders

European Investment Bank (EIB): The EU's climate bank has committed €1 trillion in climate and environmental investments by 2030, providing cornerstone capital for green infrastructure and setting market standards.

Norges Bank Investment Management: Managing Norway's $1.4 trillion sovereign wealth fund, NBIM has implemented rigorous climate risk frameworks and exercises significant influence through active ownership.

Generation Investment Management: Co-founded by Al Gore, this London-based firm manages €40 billion with fully integrated sustainability analysis and has been instrumental in developing long-term capitalism frameworks.

Climate Investment Coalition: This consortium of 12 major European pension funds coordinates €3 trillion in collective engagement on climate issues, leveraging combined ownership stakes for systemic impact.

Breakthrough Energy Ventures: Bill Gates-backed venture fund actively deploying in European climate technology, with €2 billion committed to early-stage companies addressing hard-to-abate sectors.

Examples

Example 1: Dutch Pension Fund Climate Transition — PMT PMT, the Dutch metalworking sector pension fund managing €95 billion, implemented comprehensive climate scenario analysis in 2023-2024. By mapping their equity portfolio against NGFS transition pathways, they identified €8.3 billion in high-transition-risk exposures concentrated in automotive suppliers and steel producers. Rather than divesting, PMT established engagement programs requiring companies to publish Paris-aligned transition plans by 2025. Results: 67% of targeted companies have now published approved science-based targets, and the portfolio's weighted average carbon intensity declined 31% over 18 months. The approach reduced Scope 1+2 financed emissions from 142 to 98 tonnes CO2e per €1 million invested.

Example 2: French Insurance Portfolio Optimization — Crédit Agricole Assurances Crédit Agricole Assurances, with €320 billion in invested assets, restructured their corporate bond portfolio to achieve 45% green bond allocation by end of 2024, up from 12% in 2021. The strategy targeted investment-grade green bonds with verified use-of-proceeds, achieving yield equivalence with conventional portfolios while reducing portfolio carbon intensity by 52%. Physical risk overlays were applied to their €60 billion real estate allocation, triggering €2.1 billion in asset repositioning from flood-prone coastal properties to climate-resilient urban logistics. The insurance group reports that green-tilted portfolios exhibited 40 basis points lower volatility during the 2024 market corrections.

Example 3: Nordic Sovereign Wealth Integration — Swedish AP Funds The four Swedish AP funds, collectively managing €180 billion, implemented harmonized climate benchmarks in 2024, creating Paris-aligned indices that serve as performance references across all equity mandates. These benchmarks incorporate 7% annual decarbonization trajectories and sector exclusions for thermal coal (>5% revenue threshold) and unconventional oil. By Q3 2024, aggregate tracking to Paris-aligned benchmarks achieved ITR of 1.8°C, compared to 2.7°C for conventional market-cap weighted indices. The AP funds report that the transition generated 23 basis points of alpha in 2024, attributed to overweights in renewable energy and efficiency technologies that outperformed traditional energy during the year.

Action Checklist

• Implement NGFS-aligned climate scenario analysis covering orderly transition, disorderly transition, and hot house world pathways across all material portfolios
• Establish baseline carbon metrics including Scope 1, 2, and 3 financed emissions with explicit uncertainty ranges and data quality flags
• Map portfolio holdings against EU Taxonomy technical screening criteria, identifying taxonomy-eligible and taxonomy-aligned percentages by asset class
• Develop physical risk overlays for real asset portfolios, incorporating acute event probabilities and chronic risk factors with asset-level granularity
• Create engagement programs for high-transition-risk holdings, establishing escalation frameworks that include conditional divestment timelines
• Integrate climate KPIs into manager selection and monitoring processes, specifying minimum standards for carbon data quality and scenario analysis capabilities
• Establish OPEX-based transition credibility assessments distinguishing genuine transition leaders from laggards based on operational commitments
• Implement portfolio-level implied temperature rise tracking with quarterly reporting against 1.5°C and 2°C alignment trajectories
• Develop board-level climate risk reporting dashboards incorporating both financial metrics (CVaR, stranded asset exposure) and sustainability outcomes (emissions trajectories, engagement progress)
• Conduct annual reviews of climate risk methodology, incorporating evolving scientific understanding and regulatory requirements

FAQ

Q: What KPIs should portfolio managers prioritize for climate risk assessment in 2025? A: The most operationally relevant KPIs include: (1) Weighted Average Carbon Intensity (WACI) measured in tonnes CO2e per €1 million revenue, with leading EU portfolios achieving <100 compared to benchmark levels of 150-200; (2) Portfolio Implied Temperature Rise (ITR), targeting <2°C with leading performers achieving 1.6-1.8°C; (3) Taxonomy alignment percentage, with Article 9 leaders reaching 70-80% for equity portfolios; (4) Climate Value-at-Risk under disorderly transition scenarios, typically expressed as percentage of portfolio value at risk over 10-30 year horizons; and (5) Engagement success rate, measuring the percentage of high-emitting holdings that have adopted science-based targets following active ownership interventions.

Q: How should practitioners handle the tension between short-term benchmark tracking and long-term climate risk management? A: Leading practitioners address this through explicit mandate structuring that incorporates climate-adjusted benchmarks rather than traditional market-cap indices. Paris-aligned benchmarks, which build in sector tilts and decarbonization trajectories, provide performance references that align incentives with long-term transition outcomes. Additionally, client education on tracking error tolerance and multi-year performance evaluation windows helps manage expectations. Some institutions have adopted "climate tracking error budgets" that permit deviation from conventional benchmarks specifically for climate-motivated positioning.

Q: What distinguishes taxonomy-aligned transition investments from greenwashing? A: Credible transition investments require: (1) activity-level eligibility under taxonomy technical screening criteria, even if full alignment is not yet achieved; (2) quantified, time-bound decarbonization commitments with interim milestones; (3) capex allocation demonstrably directed toward taxonomy-aligned activities; (4) third-party verification of transition plans against recognized standards such as the Science Based Targets initiative; and (5) "do no significant harm" assessments across all six environmental objectives. Practitioners should be skeptical of investments labeled "transition" based solely on announced intentions without binding commitments or independent verification.

Q: How are physical risks being incorporated into portfolio construction for European assets? A: Physical risk integration has matured significantly, particularly for real assets. Leading approaches include: geospatial mapping of asset locations against climate hazard databases covering flood, wildfire, heat stress, and sea-level rise projections; probabilistic modeling of damage and business interruption costs under different warming scenarios; valuation adjustments that reflect increased insurance costs and potential stranding risk; and portfolio-level aggregation that identifies concentration risks in vulnerable geographies. For liquid securities, physical risk increasingly informs sector allocation, with insurers and real estate companies in high-exposure regions facing valuation discounts of 10-20% relative to peers in resilient locations.

Q: What role do interest rates and macro conditions play in sustainable portfolio construction? A: The macro environment significantly influences sustainable investing outcomes. Higher interest rates disproportionately affect capital-intensive transition technologies that rely on long-duration project financing, creating headwinds for renewable energy developers despite favorable policy environments. Conversely, green bonds have exhibited defensive characteristics during rate-hiking cycles due to their institutional investor base and lower redemption volatility. Inflation dynamics also matter: carbon pricing mechanisms that escalate with inflation provide hedging properties for transition-aligned portfolios. Practitioners should incorporate macro scenarios into climate stress testing, recognizing that disorderly transitions may coincide with stagflationary conditions that compound portfolio stress.

Sources

• European Central Bank. (2024). 2024 Climate Risk Stress Test Results. Frankfurt: ECB Banking Supervision.
• Morningstar. (2024). SFDR Article 8 and Article 9 Funds: Q4 2024 Market Review. Morningstar Manager Research.
• European Insurance and Occupational Pensions Authority. (2024). Financial Stability Report: Climate Risk in the Insurance Sector. Frankfurt: EIOPA.
• Network for Greening the Financial System. (2024). NGFS Scenarios for Central Banks and Supervisors: Phase IV. Paris: NGFS Secretariat.
• European Banking Authority. (2025). Guidelines on ESG Risk Management. Paris: EBA.
• APG Asset Management. (2024). Responsible Investment Report 2024. Amsterdam: APG.
• Climate Policy Initiative. (2024). Global Landscape of Climate Finance 2024. San Francisco: CPI.