Managing Third-Party Risk in an Increasingly Connected World

Why Third-Party Risk Matters

One of the most common misconceptions is that outsourcing transfers responsibility. It does not. While an external provider may deliver an operational service, accountability always remains with the regulated firm. Boards and senior management remain responsible for ensuring outsourced activities are appropriately governed, continue to support good customer outcomes and do not expose the business to unacceptable levels of risk.

The objective is not to eliminate outsourcing but to understand where the organisation depends on others and ensure those relationships are managed appropriately.

Take a Risk-Based Approach

Not every supplier presents the same level of risk. An office equipment supplier requires significantly less oversight than a cloud hosting provider, payment processor or outsourced compliance function.

A practical starting point is to classify suppliers according to the importance of the services they provide. Consider:

• Would customers be affected if this provider failed?
• Could disruption prevent delivery of an important business service?
• Does the provider have access to sensitive customer or business data?
• Is there a realistic alternative if the relationship ends unexpectedly?

This proportionate approach enables leadership teams to focus time and resources where the operational and regulatory risks are greatest rather than applying the same controls across every supplier relationship.

Supplier Oversight Should Be Continuous

Many businesses carry out thorough due diligence before signing a contract but devote far less attention to ongoing oversight. Effective risk management continues throughout the life of the relationship.

Critical providers should be reviewed periodically to assess service performance, financial stability, cybersecurity arrangements, business continuity capability and regulatory compliance where appropriate. Significant changes, such as acquisitions, financial deterioration or major operational incidents, should trigger additional review.

Regular engagement with strategic providers often identifies emerging issues before they develop into operational problems.

Operational Resilience Starts with Understanding Dependencies

The FCA and PRA continue to emphasise the importance of understanding the resources that support important business services, including outsourced providers. Since the operational resilience implementation deadline in March 2025, firms within scope have been expected to demonstrate that they can continue delivering important business services within their impact tolerances during disruption.

For many SMEs, this does not require complex mapping exercises. Simply identifying which critical business activities rely on external providers can reveal concentration risk, single points of failure and opportunities to strengthen contingency planning.

Regulatory Expectations Continue to Evolve

Regulatory expectations continue to develop alongside increasing reliance on outsourcing. In March 2026, the FCA, PRA and Bank of England introduced a new operational incident and third-party reporting framework, which comes into force on 18 March 2027.

The operational incident reporting requirements apply broadly to many firms holding Part 4A permissions under the Financial Services and Markets Act 2000, while enhanced reporting of material third-party arrangements applies to specific categories of larger regulated firms.

Although many startups and smaller FCA-authorised firms will not be required to submit an annual register of material third-party arrangements, the direction of travel is clear. Supervisory expectations increasingly emphasise that regulated firms should understand their critical outsourcing arrangements, maintain effective oversight and demonstrate that associated risks are actively managed.

Good Governance Makes the Difference

Strong third-party governance does not require lengthy policy documents or unnecessarily complex processes. It requires clear ownership, proportionate due diligence, meaningful management information and regular review.

Boards should receive concise reporting that highlights significant supplier risks, operational incidents, emerging issues and remediation actions. The purpose of this information is to support effective challenge and informed decision-making rather than simply reporting operational activity.

Questions Every Board Should Be Asking

Before concluding that third-party risk is being managed effectively, every Board should be able to answer "yes" to the following questions:

• Do we know which providers are essential to delivering our most important business services?
• Who is accountable for each critical outsourcing arrangement?
• Do we understand our key supplier dependencies and single points of failure?
• Have contingency arrangements been documented and tested?
• Do we receive meaningful reporting on supplier performance and emerging risks?
• Would our governance arrangements withstand FCA scrutiny or investor due diligence?
• If one of our most important providers failed tomorrow, could we continue serving our customers?

A Competitive Advantage

The businesses that manage third-party risk most effectively are not necessarily those with the largest governance teams. They are the ones that understand where they depend on others, maintain proportionate oversight and act before small issues become major disruptions.

As organisations become increasingly interconnected, effective third-party governance is no longer simply a compliance requirement. It is a source of competitive advantage that strengthens operational resilience, builds investor confidence and supports sustainable growth. For startups, SMEs and private equity-backed firms, embedding these principles early creates a stronger, more resilient business that is better prepared to meet the expectations of regulators, investors and customers alike.