Cesario arrives at Olivia's palace (following Orsino's instructions in 2.4). Outside he finds Feste, who clowns a bit and mocks both Olivia and Orsino. Amused, Cesario gives him a few coins. As Feste scurries off, Sir Toby and Sir Andrew appear. Then Olivia arrives with Maria. Cesario asks to see her in private. Olivia sends everyone else away.
Feste's mockery of the noble lovers, coming directly after Toby, Andrew, and Maria's laughs at Malvolio's expense, reminds the audience that the noble lovers are not necessarily any less ridiculous than Malvolio is.
When they are alone, Cesario says that he is Olivia's servant: he is Orsino's servant and Orsino belongs to Olivia. So, by extension, he does too. Olivia says she wishes Cesario would never again speak of Orsino but, rather, woo her for himself.
Cesario's servitude metaphors create a link between literal servants and nobles metaphorically enslaved by love. Here, love makes Olivia more open and honest.
Cesario responds that he pities Olivia but cannot love her—because, as he tells her, "I am not what I am" (3.1.138). Cesario adds that no woman will ever have his heart; he himself shall be mistress of it forever. Nonetheless, Olivia encourages him to return in hopes that he will learn to reciprocate her affections.
Cesario's mysterious comment reflects the ambiguity that his disguise has created around his gender identity. Speaking of a "mistress" of his heart, he both hints at his true identity as Viola and extends the master/servant metaphor for love.