Third-party risk management essentials: Navigating regulatory expectations on outsourcing

Introduction

Within today’s interconnected financial services ecosystems, third-party relationships have grown both in importance and complexity. Financial institutions are increasingly relying on external service providers for support with delivering critical functions, spanning from core banking operations to implementing innovative fintech solutions. This has generated an unprecedented exposure to third-party risks.

Financial institutions choose to partner with a service provider for a variety of reasons, including access to specialised expertise, cost efficiency, enhanced technology capabilities, improved regulatory compliance, and the ability to focus on their core business activities. It is therefore essential for financial institutions operating within the Malta and EU regulatory frameworks to fully understand and implement a robust third-party risk management framework.

The regulatory landscape: Malta Financial Services Authority (MFSA) – Chapter 3 of the Financial Institutions Rulebook (FIR/03) and the European Banking Authority (EBA) Guidelines on Outsourcing

The regulatory landscape governing third-party risk management is evolving rapidly in response to the risks faced by financial institutions. Financial institutions are currently required to abide by the MFSA FIR/03 and the EBA Guidelines on Outsourcing as well as the Digital Operational Resilience Act (DORA) in respect of Information and Communication (ICT) third-party providers.

The EBA, recognising the emerging nature of third-party risks, has decided to update its Guidelines on Outsourcing and initiated a consultation process in July 2025 on the new Guidelines for the Sound Management of Third-Party Risk. This update broadens the scope beyond traditional outsourcing to include all third-party arrangements and aligns with the requirements of DORA.

This article will focus on the key expectations stemming from FIR/03, with particular emphasis on outsourcing arrangements - a subset of third-party arrangements - and in some cases, specifically on outsourcing arrangements of critical or important functions.

Principles for sound management of third-party risks and key expectations of the FIR/03

The following key principles provide a framework for organisations to effectively identify, assess, monitor, and manage risks arising from relationships with third parties:

i. Sound governance arrangements

Establish clear governance structures and accountability for third-party risk management, ensuring board and senior management oversight and integration with the financial institution’s overall risk management framework.

Key expectations: The board of directors remain responsible and accountable for the financial institution, including outsourced activities. The institution shall designate a key function holder or Executive Director for the management and oversight of risks resulting from outsourcing arrangements.

The institution shall have an outsourcing policy covering the roles and responsibilities of the board of directors as well as the definition of outsourcing and the criteria for identifying critical or important functions.

ii. Risk identification and assessment

Systematically identify and categorise third-party relationships and associated risks, considering the nature, complexity, and criticality of the services or products provided.

Key expectations: The financial institution shall identity, assess and monitor all risks emanating from all third-party arrangements, including conflicts of interest, regardless of whether these arrangements are classified as outsourcing.

iii. Due diligence

Conduct thorough due diligence, assessing their financial soundness, operational capabilities, compliance with laws and regulations, and risk controls.

Key expectations: The analysis should be carried out before entering any outsourcing arrangement.

iv. Contractual requirements

Ensure contracts clearly specify the rights and obligations of both parties, including service levels, risk management requirements, data protection, access and audit rights, and termination clauses to mitigate risks.

Key expectations: Contractual arrangements should grant the internal audit function the right to review any outsourcing agreement, as well as provide the institution and the competent authority with access, information, and audit rights for outsourced critical or important functions.

v. Ongoing monitoring and review

Continuously monitor third-party performance and risk exposure through regular reviews, audits, and reporting mechanisms to detect changes or emerging risks.

Key expectations: Financial institutions shall maintain an updated register of all outsourcing arrangements, documenting key details such as the nature of the function, service provider information, and risk assessments.

vi. Business continuity management

Develop and periodically review, update and test business continuity plans covering outsourced functions.

Key expectations: The contractual agreements for outsourced critical or important functions shall include requirements to implement and test business contingency plans.

vii. Exit strategies

Maintain appropriate and proportionate exit plans for planned termination and exit strategies for unplanned termination of third-party arrangements.

Key expectations: The regulator requires documented exit plans for critical or outsourced functions whenever such an exit is feasible.

viii. Proportionality

Apply the principles in a manner that is appropriate, taking into account the institution's size, internal organisation, and the nature, scope, and complexity of their activities as well as the complexity of the outsourced activity.

Emerging challenges

Emerging challenges in third-party risk management are becoming complex as organisations navigate a dynamic risk landscape:

• Information security: Third parties remain prime targets for cyberattacks and data breaches, requiring stringent controls and continuous monitoring.
• Artificial intelligence: AI adoption introduces risks around algorithmic bias, transparency, and ethical governance, demanding rigorous vendor assessment.
• Geopolitical risks: Trade tensions, regulatory shifts, and political instability create operational disruptions and supply chain vulnerabilities, requiring dedicated geopolitical risk assessments.
• Concentration risk: Over-reliance on limited providers increases exposure to service disruptions and reduces operational flexibility, necessitating vendor diversification and contingency planning.
  

Conclusion

Third-party risk management has evolved from being a mere compliance checkbox to a strategic imperative for financial institutions. To address the broad spectrum of associated risks, they must adopt a comprehensive and proactive approach. By establishing strong governance, conducting thorough due diligence, maintaining robust contractual agreements, and implementing continuous monitoring and contingency planning, financial institutions can better safeguard their operations, reputation, and regulatory compliance.

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Looking ahead: The series roadmap

This article has provided a comprehensive overview of the frameworks for assessing, monitoring, and managing third-party relationships in accordance with Chapter 3 of the Financial Institutions Rulebook (FIR/03) and European Banking Authority (EBA) Guidelines on outsourcing.

Our series explores critical risk management components essential for financial institutions operating in Malta and the EU.

• Article 1: "Risk management in Malta's fintech sector: Establishing the foundation": explores how disciplined ERM enhances regulatory compliance, protects capital, and builds trust, turning risk into competitive advantage amid evolving regulations. Discover how to strengthen governance and accelerate informed decision-making with effective ERM strategies.
• This article: “Third party risk management essentials: Navigating regulatory expectations”: provides a comprehensive framework for assessing, monitoring, and managing third-party relationships in accordance with Chapter 3 of the Financial Institutions Rulebook (FIR/03) and European Banking Authority (EBA) Guidelines on outsourcing.
• Article 3: “Beyond compliance: ISO as your security and business catalyst”: examining how information security officers (ISOs) are evolving from compliance gatekeepers to strategic partners who drive both risk mitigation and competitive advantage in the context of DORA and evolving cybersecurity threats.