What is Third Party Risk Management? [Complete Guide]
Bonus Material: 5 Steps To Better Risk Management
What is Third Party Risk Management: Introduction
A common best practice in life is to accept personal responsibility. Taking responsibility for things that happen to us is based on the belief that human beings choose – and otherwise cause – their own actions. Therefore, they impact the events that they experience. This is always true to a varying degree in our real lives, but usually one could argue that someone should not hold personal responsibility in any given situation. Real life is full of gray areas.
In business, however, things are more black and white. If calamity takes place under your leadership, deciding who is to blame is often a formal, standardized process. As a leader at your organization, how much are you prepared to be held morally and/or legally accountable for? In order to mitigate risks from materializing in the first place, you need to have a comprehensive understanding of who you trust to perform tasks you could otherwise perform yourself.
If you’re a successful business, you’ve likely earned the right to distribute responsibilities to specialized providers; your own employees may be able to satisfactorily complete the job, but if you can afford to, it makes sense to hire an expert to excel at it. Businesses everywhere rely on third party vendors to keep their operations running smoothly. But what if one of those third parties lets you down? Do you have a plan in place to prevent a mistake from turning into a disaster?
Risk management encompasses third party management on a fundamental level. Wherever you’re diffusing responsibility, it’s your responsibility as a risk manager or leader of your organization to assess and mitigate any risks associated with those third party responsibilities. This guide serves to explain exactly what third party risk management is, how exactly to take a risk-based approach to third party management and the different types of third party risks organizations may face. It will also provide critical tools and solutions for taking your third party risk management program to the next level.
What is Third Party Risk Management?
Third party risk management is often synonymous with vendor risk management. However, third party vendors are ones who your organization is involved with directly. You and a third party vendor have a contractual relationship and without them, some area of your business would collapse. It’s essential to have a comprehensive understanding of your third party vendors.
Third parties can also include your customers or regulators. It’s critical to collect their information, track what they have access to, understand what internal policies apply to them and more.
Taking a Risk-Based Approach to Third Party Management
Third party management, up until a few years ago, was viewed by many organizations as a silo’d activity separate from risk management. That’s why it’s important to explain why third party management should always be viewed as third party risk management.
Taking a risk-based approach means extending risk management processes across departments and levels of an organization. In order to implement a risk-based approach, take the following steps:
- Engage process and risk owners on the front lines through standardized, recurring risk assessments.
- Employ a common risk taxonomy to aggregate information across all departments and silos within the organization.
- Tie risks to mitigations and controls to identify the gaps between risks identified and risks mitigated.
- Present aggregated information and all gaps to leadership on a recurring basis. This drives s strategic decision making and risk-based resource allocation.
- Implement proper mitigating and monitoring activities to ensure controls are working effectively over time.
Taking these steps is a great way to create a scalable risk management program. In order to scale your third party risk management to the next level, it’s important to understand exactly how each risk activity falls within every business area. Here is a breakdown of which tools and activities fall under which area of risk management:
- Risk assessments
- Training and culture
At the core of all of these activities is engaging with your third parties in order to maintain an open line of communication so as not to miss any critical information that could impact your business.
Types of Third Party Risks
Effective third party risk management enables organizations to mitigate the risks associated with the various relationships. Depending on the area of governance they’re involved with, which information they have access to, which policies apply to them and many more factors, there are different types of risks they pose.
Risk Type #1: Reputational Risk
Reputational risk refers to the potential loss of capital or market share resulting from damage to an organization’s reputation. A myriad of things can cause reputational risks, but the most impactful is typically a company’s response to disruption. How you bounce back from a challenge is a testament to your stability, which is a major consideration for investors.
Risk Type #2: Operational Risk
When your company valuation is at risk of falling due to failed internal processes, you face operational risk. Organizations are especially at risk when inadequate systems or external events differ from their expected losses. There can be lasting damaging effects as a result of operational failure, like lower market valuation or higher credit costs.
Risk Type #3: Regulatory Risk
This refers to the risk that a change in regulations or legislation will impact a company. Failure to be in compliance with ever-changing regulations puts you at risk of being fined, sued, de-licensed and more. To mitigate this risk, organizations need to be able to anticipate and adapt.
Risk Type #4: Fiscal Risk
Fiscal risk refers to deviations of fiscal outcomes from what was expected at the time of the original forecasting. Sources of fiscal risk can include shocks to the economy (both positive and negative), interest rate changes, commodity prices and more.
Third Party Due Diligence Checklist
When you’re evaluating third parties to sign onto a contract with, it’s critical to conduct due diligence to ensure that they’re a good fit for your business. Applying a checklist helps you streamline your vendor management program because it’s a repeatable process. Below are the key criteria under which areas you should focus on when vetting potential vendors (or even when assessing existing vendors):
- Conditions of their plants/facilities
- Does the staff have effective cleaning measures in place? Is the location exposed to hazardous matter? Is the internal environment properly climate controlled?
- Staff training policies
- How are their employee retention rates? How comprehensive is their worker training program? Is there a clear (and skilled) leader?
- Cybersecurity practices
- How do they manage and protect their data? Is access to sensitive information controlled and limited to specific users? What is their maintenance schedule?
- Business continuity processes
- How easily can they identify key operational personnel? What is their recovery point objective (RPO) and recovery time objective (RTO)? Have they prioritized an off-site backup?
Third Party Risk Assessment Template
Let’s revisit step 1 in the list of steps to take in order to implement a risk-based approach to third party management: engage process owners through standardized risk assessments.
To assess third party risk, it’s important to consider a variety of factors. But how do you focus on the most important ones and decide what exactly will impact your risk management efforts? Here are some considerations that you can use to create a formalized risk assessment process:
- Define the business area
- Describe the risk
- Determine the source of the risk
- Consider what could go wrong if that risk manifested
- Quantify the impact
- Consider the likelihood
- Decide the assurance against it
- What is the inherent risk?
- What is the residual risk?
- Are there further mitigation efforts needed?
- Lay out a mitigation plan
- Assign a mitigation activity owner
Once you fill out all of the information on this risk assessment template, you are in a much better position to stay protected from that particular risk. Be sure to conduct this risk assessment using a consistent template every risk that affects your organization.
Solutions for Third Party Risk Management
Leveraging robust risk management software is the only way to ensure that you’re solving problems within every area of your organization. LogicManager offers software that provides comprehensive third party risk management solutions. Using our software, you can empower your organization to leave manual processes and data validation behind and earn back time and energy, allowing you to focus on overarching, strategic goals.
Eliminate virtually all ancillary processes utilized for tracking, reviewing, reporting and risk assessment creation through LogicManager’s connected platform. Under a manual system, your database of risk information is likely incomplete. With LogicManager, you can also remediate audit findings and regulatory requirements to increase efficiency and data management.
With your third party risk management process improved, you gain access to an enterprise-wide view of your risk at all times. This helps you prove and grow your expertise to investors and potential customers alike. The best part is that when you partner with us, we’re along for the ride. We’ll get you up and running with one-on-one training sessions, help you build the reports you need and are available to answer questions at any time.
As we’ve made clear, third party risk management starts before the relationship is official; so begin your vendor due diligence by connecting with us or checking out our software in action to learn more today.