The 20-year-old attacking midfielder is believed to be growing frustrated at the La Liga side who currently sit fourth in the table, and Premier League clubs have been alerted by a £17million buy out clause in his contract.
Malaga are reluctant to let go of a player who is expected by many to eventually become a regular in the Spanish national side, and it is reported that they are looking to tie Isco down to a new contract with a revised release clause in the region of £30million.
It was believed that City were the front runners for the players signature, however Chelsea owner Roman Abramovic has expressed his interest in bringing him to Stamford Bridge as he continues to push Chelsea in the direction of adopting a philosophy of playing attractive football with flair.
Isco came to the fore last season following his move from Valencia as he helped his Malaga side finish in a Champions Leage place, scoring five goals in 32 league appearances along the way.
He was nearly sold to Tottenham in the summer to ease the clubs financial situation, however they have now balanced the books and are keen to hold onto their player who has helped them into the knockout stages of this years Champions League.
Manchester City will remain hopeful that they can beat new competition for the players services, and bring him to the Etihad.