Every business enters into agreements with Third Parties. In some cases, those agreements may be for the outsourcing of particular operational elements for the purpose of cutting costs. In other cases, these agreements will govern the supply of resources and relationships with clients and employees. In all cases, a range of risks are associated with Third Party collaboration, and it is essential for the business to manage those risks effectively.
In the broadest of terms, Third Party Risk Management boosts efficiency and productivity within the organization. If less resources and less time is spent dealing with issues caused by Third Party risks being realized, then the entire operation is more streamlined and functions in a cohesive, optimal way. Streamlined efficiency creates increased profitability, along with a higher degree of scalability within the global marketplace. In this way, effective Third Party Risk Management makes a significant contribution to business continuity, and the future-proofing of the operation.
Categorizing risk
When we talk about Third Party risk, we are using an umbrella term. ‘Third Party risk’ describes all risks associated with a Third Party, with which the business considers entering into a contract. Part of that consideration is identifying risks and analyzing their detail in the context of the risk appetite and risk tolerance of the business. Risk appetite is the specific level of risk the business can withstand in terms of potential revenue loss. Risk tolerance is the more diffuse ‘buffer’ around that risk appetite figure, allowing for a small amount of flexibility in analysis.
Once Third Party risks have been identified within the framework of risk appetite and risk tolerance, it is vital that the business categorize them. Categorization enables businesses to clearly define several key things:
- The type of risk associated with the Third Party
- The level at which those risks can currently be measured
- The external and internal factors, or market circumstances, which could change that risk level
Taking these elements into consideration, the process of risk categorization enables Third Party Risk Management to take a more detailed, granular approach which provides a level of protection for the business that is far more powerful than that which is achieved with a more broadly applied risk assessment. Once risks have been categorized, mitigation methods and decisions can be tailored more closely to each potential threat, creating a risk defence system that is far more stringent and efficient overall because it enables the business to target precisely the types of risk that pose the biggest issues.
Monitoring risk
The identification, categorization and initial assessment of risk is the essential early stage of Third Party Risk Management, but in order for a Risk Management program to be truly effective, risk must be consistently monitored. This is because a wide variety of factors can cause changes to the level of potential damage a risk may cause, and those factors may relate to the business, or the Third Party, or even both simultaneously. It is the fact that so many variables are involved in business risk that make it so vital to take this approach, which mirrors the monitoring of Key Performance Indicators in Contract Lifecycle Management.
Like the monitoring of contract performance, each business needs to determine which risks need to be monitored, and this will depend on the nature and objectives of the operation, as well as the nature of the Third Party. Broadly speaking, however, there are six main Third Party risks that may apply, and which are important to monitor:
Compliance risk
The area of compliance needs to be a very high priority for every business. It is about ensuring the adherence to the rules, laws and regulations that govern the operation. There are three types of compliance that businesses must work through:
- Internal – Every business must comply with its own internal policies and regulations. These are determined and agreed by leadership and stakeholders and are designed to reflect the values and objectives of the organization. These types of policies will set out standard terms and conditions of everything from employment to sales and purchases.
- External – Businesses are required to comply with external regulations and legislation that govern the way in which they operate within the industry in question, as well as within the territorial or jurisdictional context of the enterprise. This type of requirement will include rules regarding transactions, data security and employment.
- Contract – Ensuring that the business complies with contractual responsibilities and obligations is a core part of both Contract Lifecycle Management and Risk Management.
Financial risk
In terms of Risk Management, financial risk generally takes the form of excessive costs or revenue loss. In terms of Third Party risk, these two types of financial risk can occur in a variety of ways.
- Excessive costs – If a Third Party does not comply with agreed contractual terms, then excessive costs can be incurred. That means costs which exceed those expected, for which the business has budgeted. Similarly, if a Third Party needs to consistently amend its agreed terms to accommodate poor initial planning, then project costs can begin to spiral.
- Revenue loss – Problems with Third Party contracts can incur penalties and even the loss of sales. Overall, the impact of such issues can be the loss of revenue for the business.
Strategic risk
When a business enters into a contract with a Third Party and, during the contract lifecycle, the Third Party makes strategic choices and decisions that are not aligned with those of either the agreement or the business, then this becomes a strategic risk. For example, if the business operates a policy of non-engagement with organizations that invest in particular technologies, and the Third Party opts to contradict that in its own investments, this can be damaging to the original business in terms of both immediate profitability and commercial viability in the future.
Security risk
In the modern global marketplace, data security and cyber security are notable areas of focus. International legislation has been created and adopted to ensure that the privacy and security of commercial and individual data is protected to the highest possible degree. In the case of many organizations, contractual agreements can hinge on whether or not the business demonstrates compliance with all such legislation and guidance. This is because failure in the area of security can lead to catastrophic damage to all parties. In addition to incurring large penalties and reputational damage, breaches of security can lead to the loss of intellectual property and overall revenue.
Operational risk
Operational risk is a business continuity issue. If a Third Party does not have an effective business continuity plan in place, then any shutdown or interruption in service – however brief - can have a highly detrimental effect on the daily operation of the business, as well as its ability to fulfil its own contractual obligations.
Reputational risk
For every business, reputation is key. The reputation of a business consists of the overall public perception of the organization and is generally built over time, through compliance with standards and an adherence to a clear set of ethics. It is always hard-won and, when protected, makes a significant contribution to revenue streams and the overall value of the enterprise. By that same token, damage to the reputation of a business can take years to repair, and the decisions that businesses make with regard to Third Party engagement are a significant reputational factor. From the perspective of the public, the Third Party choices that the business makes are reflective of both the core values of the organization, and the meticulousness with which it undertakes due diligence.
There is a great deal of intersection between these types of risk because risk does not exist in a vacuum. Failures in compliance, strategy or security can have far-reaching consequences in terms of operational, financial, and reputational risk. Likewise, there is intersection between the management of these risks internally, in terms of the conduct and processes of the business itself, and in terms of Third Parties. Just as the first business executes stringent Third Party Risk Management, so does the Third Party before engaging with the business. This is why it is absolutely vital to monitor these risks consistently, throughout the duration of the contract lifecycle, as opposed to limiting Third Party Risk Management to the initial contracting stages only.
The Contract Management Software designed by Symfact provides all the tools necessary to carefully monitor Third Party Risk, as a core function of Contract Lifecycle Management processes. Using cloud technology to deliver a platform that is built around a centralized repository, Symfact’s digital solution supports comprehensive risk assessments and background checks on organizations and individuals alike, while harnessing automation for thorough, scheduled review. Standardization is enabled, to build Risk Management into the daily function of the business, and Identity Management features help to detect and prevent fraudulent activity. Moreover, links to leading external databases - including LexisNexis, Refinitiv, Dow Jones and Dun & Bradstreet – ensure that all risk-related monitoring and decision-making is based on the most current and actionable data available.
Contact Symfact today to learn more about how Contract Management Software can enable the monitoring of Third Party risk and book your demonstration today.