Third party data processing is where your organization utilizes the services of another organization to perform some action involving the data supplied or gathered on behalf of the originating party. That service may store, process, gather, transform, or otherwise have access to the data for your business purposes.
They ask about the use of third party data processing because their use introduces additional factors in their management of data to meet legal and regulatory requirements. Additionally, every party that has access to the data could be a weak spot where the data may be disclosed, changed improperly, or lost.
They expect the disclosure of any use of third parties. The use of third parties will require more information to be provided about the handling of their data by third parties. Likely, additional questions will include the nature of the relationship to the organization, where the data will be stored and processed, and what security measures will be taken by the third party.