Driving Sustainable Value Creation in Private Markets

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As Global Head of Impact at Carlyle, Megan Starr is at the vanguard of the private equity firm’s portfolio company engagement work on material ESG issues. A core focus of her work is helping companies transition to a lower-carbon economy, which is increasingly important for companies to remain competitive, drive stronger performance, and deliver improved results for investors.

As a Pathfinder, Megan knows that private markets have a key role to play in the path to a more sustainable future. In our interview, we sit down with Megan to discuss the role of private equity in the energy transition and how she works with business leaders to drive toward sustainability outcomes that Carlyle believes are financially accretive.

Can you tell us about the career path that's led to your current role at Carlyle?

My passion for sustainability started quite early on. I grew up in a very environmentally oriented household and chose to study climate change in my undergraduate years; from there, I moved into working in philanthropy for a private family foundation where I focused on a wide range of environmental issues. This got me interested in exploring how for-profit businesses were solving and scaling solutions to address environmental and social challenges. Following business school, I landed at Goldman Sachs, where I focused on how to institutionalize the integration of ESG factors across investments to drive sustainable performance.

I came to Carlyle four years ago because I was excited by how Carlyle was thinking about the role of private capital, and wanted to take on the challenge of reimagining what the ESG integration platform could look like. Historically, private equity’s goal has been to buy good businesses and turn them into great businesses (to oversimplify). When I joined Carlyle, there was already growing conviction around the idea that great businesses in the 21^st century could potentially use sustainability strategically to drive business performance. ESG integration is a set of tools we use across our investing activity to drive progress on financially material characteristics – it’s not a separate fund, or a standalone division.

What are the core drivers of your work at Carlyle?

There are three core tenets to how we operate.

• Continually reimagining what good ESG integration looks like. Materiality is dynamic, and that means we cannot ‘set it and forget it.’ There are always new material ESG issues coming down the pike that we need to understand and diligence, such as human rights in supply chains or a company’s impacts on biodiversity – two issues that have really come to the fore in recent years. To do this, our team is always looking at new datasets, resources, and tools to help us have better and more accurate information and insights. This isn't a static field: new issues and opportunities are always emerging.
• Driving market practice. Carlyle co-created the ESG Data Convergence Initiative (EDCI) two years ago along with CalPERS and a global group of Limited Partners (LPs) and General Partners (GPs) – EDCI is intended to be a practical solution to cut through the proliferation of ESG frameworks and reporting definitions to a core set of comparable, quantitative, performance-based metrics across private markets to help see exactly where and how ESG drives performance.
• Demonstrating commercial value and outcomes. As one example, Carlyle’s Capital Markets team has structured about $26Bn of ESG-linked financings across our portfolio companies and fund lines of credit, including an ESG-linked bilateral fund line of credit with RBC Capital Markets. This is a clear and tangible way of linking progress on material environmental and social topics to potentially lower cost of capital for funds and companies.

How does your team manage the complexities of ESG?

For performance-oriented sustainability strategies to really take root, I think you need a combination of systematic and bespoke support for portfolio companies. There are some things that are good business practice and good hygiene that we can help scale systematically across our portfolio companies – things like access to carbon foot-printing software, best practices on board governance, and a playbook on Diversity, Equity, and Inclusion (DE&I) that maps out how to measure and incentivize change.

I also think it is important to combine all of that with bespoke engagement. Our team basically functions as a “sustainability SWAT team” that engages with companies on a much deeper level. It's easy to talk about how to drive change, but it’s only when you get into the weeds of a business that you realize what is and isn’t achievable, and that’s when you find the real windows of opportunity.

“Our team basically functions as a “sustainability SWAT team” that engages with companies on a much deeper level. It's easy to talk about how to drive change, but it’s only when you get into the weeds of a business that you realize what is and isn’t achievable, and that’s when you find the real windows of opportunity.”

How are your portfolio companies balancing today’s near-term macro challenges with longer-term sustainability strategies?

One of the biggest challenges of ESG and sustainability is the ‘time lag of materiality’. We believe that preparing a carbon-intensive business to thrive in a decarbonizing world may start to pay dividends years from now, but some parts of that might show up as a cost in today’s earnings. It is very difficult to quantify the concepts of risk avoidance and longer-term value creation, which can make it difficult for leaders to invest in longer-term sustainability initiatives when there are other, potentially more pressing, near-term macro and business issues facing them.

We recently titled our annual firmwide ESG report the ‘EBITDA of ESG’ to emphasize the potential for ties between ESG improvements and their financial impact on a company’s profitability. Focusing on where ESG can be an immediate value driver – whether by helping companies to win new sales or achieving cost savings by reducing energy use – can help leaders draw more tangible connections between sustainability and performance. Finding ways to reinforce the direct link between ESG and business performance measures such as EBITDA can help business leaders prioritize, build buy-in, and put momentum into longer-term sustainability transformation.

“Finding ways to reinforce the direct link between ESG and business performance measures such as EBITDA can help business leaders prioritize, build buy-in, and put momentum into longer-term sustainability transformation.”

How are you managing to translate the growing volume of ESG data into actionable insights?

My preference is for fewer, better data points. Asking less mature private companies for hundreds of ESG data points is going to yield a much lower quality output versus asking for a smaller set of the most meaningful data points. Part of a private equity firm’s role is to build the capacity for companies to collect high quality, useful performance data – for ESG and beyond – and build that maturity over time. Sometimes it feels like the ESG industry is too eager to get to the finish line with data measurement, instead of meeting companies where they are and helping them get onto the course.

I also think static data tends to be less helpful than time series data. A carbon emissions intensity number on any given day for one company versus another doesn’t tell me a lot. It’s far more helpful to get time series data (along with peer benchmark data) to understand how a company’s performance is changing over time and how that stacks up to intra-industry competitors.

There’s also a tendency to aggregate a lot of disparate underlying ESG data points to give a headline score. I prefer discrete data points that are ideally performance-based and focused on individual, material aspects of ESG performance, such as greenhouse gas emissions, renewable energy purchasing, and actual hiring and diversity rates.

How has the field of ESG evolved over the course of your career?

The metaphor I like to use is one of a growing person. The industry was in its infancy when I started out, and we really went through a teenage growth spurt over the last few years into almost ‘ESG-mania’. We’ve had some growing pains, but will come out the other side more mature.

In this next phase, I see a real focus on not overclaiming, not overhyping, and not overpromising. We need to get back to brass tacks: where and how does ESG drive financial performance. We are entering a moment of maturation with spotlight on the industry. Scrutiny can be good – it helps sort the wheat from the chaff, pushes practice, and helps the field narrow in on how to clearly demonstrate the tie between financial factors and sustainability.

“In this next phase, I see a real focus on not overclaiming, not overhyping, and not overpromising. We need to get back to brass tacks: where and how does ESG drive financial performance.”

What’s your outlook for the ESG space over the next few years?

When it comes to ESG, I would say most stakeholders agree that using all the tools at an investor’s disposal as a lever to drive better financial performance is a good thing – be they sustainability tools or otherwise. In that respect, investors want more, better, faster.

There are so many new issues coming up in this broad field of sustainability. One risk is that we lose focus on one of the largest investment challenges and opportunities of the next few decades, which is the energy transition. For me, the energy transition underpins and exacerbates so many of the other challenges that we're seeing from both a business and a societal perspective, so being able to stay focused on what matters most is a really valuable discipline.

I think ESG professionals will need to become even more interdisciplinary across topics like carbon accounting, environmental permitting, health and safety, diversity, ecological impacts, decarbonization pathways, and a whole host of other disciplines to be able to continue to spot what really matters for a specific business. I expect to see even greater specialization of those skill sets going forward.

“When it comes to ESG, I would say most stakeholders agree that using all the tools at an investor’s disposal as a lever to drive better financial performance is a good thing – be they sustainability tools or otherwise. In that respect, investors want more, better, faster.”

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