Introduction
In this post, we’ll answer the essential question: What is Third Party Risk Management (TPRM)? Drawing from our Third Party Risk Management 101 Guidebook, this blog can be used as a starting point for those that wish to establish, validate, and/or enhance their Third Party Risk Management Program. We’ll introduce you to the foundations of TPRM and why it’s critical for organizations today.
We’ll break down the basics, including key definitions, the various types of risk posed by third parties, how to assess and measure these risks, and the first steps to managing and mitigating third party risk exposure. Whether you're new to TPRM or looking to enhance your program, this post will guide you through the essentials.
Definitions
What is a Third Party?
For our purposes, Third Party will be broadly defined to include all entities that can or do provide products and/or services to an organization regardless as to whether a contract is in place or monies are exchanged. Such entities can include, but not be limited to: Affiliates, Subsidiaries, Consultants, Contractors, Subcontractors, Vendors, Service and Solution Providers, Fourth parties, and more.
Historically, organizations procured services from third parties for cost-efficiency purposes. Today, the purpose of procuring third party products and services has greatly evolved. Now, it includes, but is not limited to:
Outsourcing critical processes
Quickly scaling services to reach global markets
Focusing on more strategic priorities
Reaching niche markets
Gaining additional expertise and functionality
As this evolution occurs, the risk and impact posed by third parties to organizations increases.
Therefore, Third Party Risk is the possibility of an adverse impact on an organization’s data, financials, operations, regulatory compliance, reputation, or other business objectives, as a direct or indirect result of an organization’s third party.
So, how do you properly mitigate third party risk? By having a strong TPRM program. But what does TPRM entail?
Third Party Risk Management (TPRM) is the framework that consists of policies and procedures, controls, governance and oversight; established to identify and address risks presented to an organization by their third parties.
A Control is a process and/or activity used to monitor, review, and/or address a specific risk.
What is TPRM?
Third Party Risk Management is not a new concept, but its importance continues to grow due to:
The threat landscape growing in complexity
Organizations having a greater reliance on third parties to support critical services
Digital transformation projects growing in momentum
Increasing regulations
Environmental impacts
In addition, there has been an increase in regulatory scrutiny of organizations, to ensure they are aware of the risks and impacts their third parties have on their organization. Gone are the days when organizations could simply attest that they have a compliance program in place. Regulators now require organizations to demonstrate that their third parties have effective controls and compliance programs in place.
To ensure that third parties operate securely and effectively, an organization must implement and maintain an effective Third Party Risk Management (TPRM) program to identify, assess, monitor, and mitigate risks related to the outsourced data and processes. Customers, board members, and regulators have significant expectations that organizations will maintain effective TPRM programs. These stakeholders seek assurance that the organization is appropriately identifying and managing third party risks to protect their interests and uphold compliance standards.
But what risks specifically should a TPRM program consider?
Potential Risks with Third Party Relationships
Organizations that hire third party services frequently share data and intellectual property with those providers.
For our purposes, Organizational Data will refer to all proprietary and restricted data a company holds, processes, and/or secures, including their customer’s personal data
Third parties often access, transfer, manipulate, and store organizational data, which increases the risk for the organization that owns this data. While third parties share some responsibility for protecting this information, the primary responsibility lies with the organization itself. It is crucial for the owning organization to ensure that third parties are properly safeguarding both their data and their customers’ data. An organization is only as strong as its weakest link, which may be a third party.
The risk of engaging with a third party depends on the type of relationship between an organization and the third party, as well as the controls that the third party has in place. While there is no way to completely eliminate the risk of a data breach or verified incident, there are security measures that can be taken by the organization to ensure they understand the risk of working with the third party and take appropriate steps to mitigate the risk.
Failing to properly identify, assess, and manage the risks associated with an organization’s relationship with third parties can lead to significant consequences. It can attract scrutiny from regulators, result in fines and other legal repercussions, and pose serious reputational or financial risks to the organization’s relationship with its customers.
What Types of Risk Are There?
A third party relationship can introduce many different types of risk to an organization. TPRM programs are no longer focusing on only cyber risk, as there is an increased need to expand their risk view. Now, TPRM programs must review an organization’s financials, operations, and even environmental and social impacts.
Social Impacts relate to labor practices, environmental controls, and organizational governance practices.
Here are just a few types of risks a third party could present to your organization:
Reputational Risk
Operational Risk
Strategic Risk
Transaction Risk
Financial Risk
Cybersecurity Risk
Environmental Social Governance (ESG) Risk
Compliance Risk
Other types of risk vary based on businesses' use of third parties, the efficacy of third party internal controls, and the locations in which they operate.
Organizations must carefully evaluate the controls of their third parties to ensure that risks are avoided, mitigated, shared, transferred, or accepted according to their risk management framework, which is guided by their risk appetite. An organization’s risk appetite refers to the level of risk that it is willing to accept or reject. Every organization possesses a risk appetite, even if it is not formally documented. If your organization doesn’t have a formal risk appetite statement, it’s important to closely monitor the third-party risks that are accepted or overlooked, as these choices can provide an informal understanding of the company’s risk appetite. Essentially, paying attention to how your organization handles these risks can help clarify its risk tolerance.
The Evaluation of Third Party Risk
Assessing third party risks and the controls in place to mitigate those risks is crucial when deciding whether to contract with a third party provider. It is also important to how the organization will conduct ongoing monitoring of the relationship. Understanding the nature of the services that the third party will provide is essential to grasping their potential impact on your organization. This knowledge enables businesses to proactively prepare for any challenges that may arise if the third party fails to deliver the promised products or services.
The key to effectively leveraging the products and services of a third party, in any capacity, is for an organization to properly identify, assess, mitigate, and monitor risks associated with doing business with their third party.
There are two types of risk: inherent risk and residual risk.
Inherent risk refers to the level of risk associated with a third party product or service. An inherent risk assessment does not consider any third party controls that may be implemented to mitigate these risks. When assessing inherent risk, several factors are considered, including the nature of the product or service offered, the type of data accessed or transferred, the geographical location of the third party, and the financial amount involved. Importantly, it does not include any protective measures the third party may have established to reduce those risks.
Inherent Risk
Residual Risk
Formula for Risk: Risk = Impact of Risk x Likelihood Risk Will Occur
Risk is calculated by multiplying the level of risk (meaning the impact it could have on the organization) by the likelihood that it will occur. The velocity at which risk could occur may also be considered when calculating likelihood.
What to do with Discovered Risks
After an organization calculates the risk associated with a third party, it may choose to accept, remediate, share, transfer, or avoid the identified risk. The following outlines how each of these options functions.
Accept
Remediate
Share
Transfer
Avoid
Regardless of how an organization chooses to address risk, it must first have processes in place to discover and assess it. This is accomplished through the implementation of a strong Third Party Risk Management Program.
Conclusion
In conclusion, Third Party Risk Management (TPRM) is a crucial aspect of ensuring an organization's security, compliance, and overall resilience. As reliance on third parties increases and the threat landscape becomes more complex, implementing a well-structured TPRM program is essential. By identifying, assessing, and managing the various risks presented by third parties—such as operational, regulatory, reputational, financial, and cyber risks—organizations can proactively mitigate potential threats. Through effective TPRM practices, businesses can better protect their operations, maintain regulatory compliance, and preserve their reputation in an ever-evolving risk environment.
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