We live in a connected and digital world, in which third-party relationships extend the opportunity for organisations for greater agility by minimising delivery time, while also reducing costs. Despite the spectacular opportunities, third-party relationships also open the door to a host of new risks – strategic risks, operational risk, and business continuity and resiliency risk, to name a few. Organizations that will be successful in this groundbreaking era are the ones that competently generate value from risks across their businesses. This blog post is intended to further your understanding of third-party risk management and to provide expert information on how to develop a healthy third-party risk management program.
Table of Contents
What is third-party risk management?
By definition, third-party risk management is the process of analysing and controlling risks associated with parties and service providers outside the company. Today, organisations are increasingly relying on third parties to attain their strategies and business objectives. In fact, this is a very cost-effective and efficient strategy.
Third-party relationships comprise a wide network of relationships across the organisation which includes suppliers, service providers, distributors, product resellers, regulatory agencies, joint ventures and many more. What’s more, these relationships become an indispensable part of how companies conduct business. Third parties often make a tangled web of interlaced relationships and they carry extended enterprise risk. Therefore, it is imperative that companies not only do understand third parties but also properly manage the risks that come along with them.
Potential risks arising from third-party relationships
There are numerous risks that organizations using third parties need to consider. These risks are strategic, financial, geopolitical, regulatory, digital, cyber and privacy, and reputational. The level of exposure to these risks is heavily based on how organizations are leveraging third parties. Some of the risks are linked to the underlying activity itself, similar to the risks faced by an organisation directly carrying out the activity. Other potential risks are stemming out of the involvement of a third party. For instance, third parties may pose a serious impact on an organization’s operational risks if a third party provides a critical product and service to the organization.
Please be informed that not all of the risks described above will be applicable to every third-party partnership. Here we will walk you through 4 potential risks that arise from third-party relationships: strategic risk, compliance risk, operational risk, and transaction risk.
- Operational risks are the risks of loss rooting from insufficient or unsuccessful internal processes, systems, or from external occurrences.
- Strategic risks are the risk deriving from unfavourable business decisions, or the failure to execute adequate business decisions in a way that is harmonious with the organisation’s strategic objectives.
- Compliance risks are the risks originating from breaches of laws, rules, or regulations, or from noncompliance with internal policies and procedures or with the organisation’s business standards.
- Transaction risks are usually resulting from problems with service or product delivery. A third party’s failure to function as anticipated due to reasons like insufficient capacity, technological failure, human error, or fraud, greatly exposes the organisation to transaction risks.
Developing a third-party risk management program
Building a third-party risk management program is an important undertaking. In this section, we outline the 4 essential steps that you will need to consider when creating your requirements for a robust third-party risk management solution.
1. Identifying the risks posed by your organisation’s use of third parties
Firstly, any company should begin by rigorously sifting through and categorising its third-party groups as well as the risks they pose. The objective here is to come up with a prioritised list based upon the probability and impact of harm to the organisation. From there, the organisation should identify a mitigation strategy to manage the risks. It is not to be forgotten that while classifying and knowing the risks associated with the third parties is critical in the beginning, the long-term management of the relationship is necessary for success.
2. Performing due diligence on contracting the right third party
The due diligence process grants management the vital knowledge needed to address all aspects of potential third parties to ascertain whether or not a relationship would help fulfil the organisation’s strategic business goals and alleviate identified risks. We also must note that third-party due diligence is not one-size-fits-all. There are a number of organisational attributes, such as the region in which the organisation operates and where the third parties are located, that dictate what the internal process is going to look like.
3. Defining policies and procedures for monitoring third parties
This far, you already know the risks that third-parties pose, but you also need to consolidate the types of software, services, networks, devices, or any data that third-parties access. Policies and standards set clear roles, responsibilities and expectations for every stakeholder involved in an organization’s third-party risk management program initiatives. Simply put, it is critical for all stakeholders to know their responsibilities when engaging a third party.
4. Maintaining adequate oversight of third-party activities
Organisations should maintain sufficient oversight of third-party activities and sufficient quality control over the products and services provided through third-party arrangements. Management should continually evaluate the third-party operations with the aim of validating that they are in accordance with the terms of the agreement and that risks are being controlled. The scope of overseeing a specific third-party partnership will be dependent on the possible risks.
The benefits of a strong third-party risk management program
The process of establishing a strong third-party risk management program is not an easy feat. Yet, if implemented and managed adequately, the program comes along with overarching benefits. For example:
- in terms of quality, it provides stronger controls and increased accountability over third parties;
- in terms of efficiency, the well-established program offers an enhanced ability to promptly launch new initiatives and locate third-party replacements more rapidly, whenever needed;
- in terms of flexibility, it offers greater agility in reacting to changing regulatory requirements and other third-party risk management difficulties.
Conclusion and next steps
There is an increased dependence on third parties, and this is not going to change anytime soon. Escalating use of third parties across the organizations indicates that there is a need to critically evaluate which third parties an organization is using and how much risk they create. It is our hope that now you see a clearer picture of the risks created by your organisation’s use of third parties. Risk has always been seen as something to be prevented, however, the risk is also an originator of value and can play a substantial role in driving business performance. No third-party relationship is constant, and it is more than likely that the risks will continue to expand. Hence, we advise you to remain abreast of the third-party relationship and oversee any changes occurring.