I've found some information about this across steam forums, but it seems mostly outdated and not very concrete. I was interested in making a build around this mechanic, so I'm posting a few findings I have so far as they disagree with some old posts I read:
- Conversion only affects weapon/shield base physical damage, bonus physical damage on the weapon itself is treated as base damage and is thus affected. Any other flat physical from items/buffs/passives/procs/skills isn't converted.
- It also doesn't affect the flat phys from STR. STR and %increased physical don't interact with converted damage at all. Conversion takes place before these are applied and also before pierce ratio.
- Similarly it doesn't affect physical skills that don't use your weapon, unarmed punches, flat physical thorns or reflected damage.
- Converted melee damage cannot crit, but the remaining physical/pierce part can. This means crits will often be displayed if your OA is high, but it'll only multiply the leftover damage from you flat physical sources after conversion.
- There is a 100% conversion cap on the mechanic. I saw past evidence that conversion could go past 100%, but this is no longer the case.
- Conversion stacks additively, and conversion effects from weapons aren't local- meaning if you dual wield 50% conversion weapons both of them will have 100% conversion.
- Transmutation (the runes skill) is a global passive, and in practice unlinked to Rune Weapon. With a maxed Transmutation all applicable attacks will have the 99% conversion regardless of skill used.
That's about it, initially the thread was going to have a few more questions in it, but I extended testing a fair bunch and ended up clearing most of it along the way. I haven't posted proof of the testing since I would need screenshots for every single damage instance and I couldn't spare the time to set up all of that, but everything mentioned is tested ingame with the displayed damage on dummies.
If you have anything to add or see something that doesn't fit your experience, please feel free to mention. I think I was thorough in everything I checked but it's always best to have further data.