Thanks Tryninja,
So my assumption that a xpub key can be generated from a seed, but not the other way around (generate seed from xpub) is correct?
Yes. To spend the coins, you'll need to have all 3 xpubs (regardless of which 2 parts you use to sign). That's why you either need to put all 3 seeds in each location (which would make the whole multisig scheme useless, so it's not an option) OR all 3 xpubs in each location. All the xpubs gives to the one with access to it is the watch-only wallet, so that's not a security issue.
Your image above is correct.