Published in Real Clear Markets:

It was a relief to hear Federal Reserve Chairman Jerome Powell say recently that regulators “have to get it right” and will make changes to a controversial proposed bank capital rule – known as Basel III. It matters to investors and businesses everywhere because, without a course correction, central clearing in the U.S. could be in jeopardy, meaning more risk and less stability in our markets.

While not a common household or even investing topic, central clearing is the hub of the market ecosystem. It is the essential, arm’s length backstop that keeps our modern, fast-paced markets working – largely unseen and taken for granted. A clearinghouse stands as a bridge between buyers and sellers; it acts as the seller to every buyer, and the buyer to every seller. This crucial low-margin, high-volume role gives confidence to buyers and sellers that their transactions will go through and not fail, because the clearinghouse guarantees the trades with assets in hand from one party and the instruments to be traded from the other.

After the 2008 financial crisis, policymakers and regulators committed to expanding central clearing of financial products due to its effectiveness at supporting stable markets by reducing risk and increasing transparency.

Chairman Powell has earlier spoken of the importance of clearing and the intertwined relationship between capital and clearing when he said regulators “have a responsibility to ensure that bank capital standards and other policies do not unnecessarily discourage central clearing.”

That’s why it was baffling to see that the cumulative effect of the original Basel III proposal would do just that. A Futures Industry Association study found that the original proposal would increase by more than 80 percent the capital requirements for clearing. The proposed rule would impose this significantly increased cost without evidence that current capital requirements for clearing are inadequate. The end effect of this increase would ultimately discourage central clearing.

CFTC data shows the risk is real that increased capital requirements would result in fewer clearing entities. Since the Dodd-Frank Act reforms went into effect in 2014, there were 22 futures commission merchants (FCMs) providing OTC clearing services in the U.S. Today, there are 12 clearing firms, and 7 of these firms make up 94 percent of the market.

The Options Clearing Corporation (OCC) recently explained its concerns about marketplace concentration in the Listed Options market in which only three bank-affiliated clearing members account for more than half of the cleared volume in OCC cleared contracts.

Meanwhile, demand for clearing is on the rise. Data from the FIA finds the amount of funds posted by customers in cleared swap accounts has been rising steadily over the last 10 years, but the number of firms able and willing to provide that service has been cut almost in half.

Earlier this year, Commodity Futures Trading Commission Commissioner Summer Mersinger outlined in a speech how the Basel III proposal’s bank capital requirements would weaken clearing and what that means more broadly for the markets: “harm derivatives end-users that rely on clearing services, increase risk in the global financial system, and raise the cost of living for our families.”

We must remember that “derivatives end-users” are people and businesses such as farmers, fishers, ranchers, manufacturers, and airlines that want to smooth out volatile commodity costs such as raw materials and fuel in our inflationary, sometimes chaotic times.

As former regulators from the equities, options and futures agencies, we have deep reservations about any proposal that would further diminish the dwindling number of banks willing to offer clearing services, and in turn decrease liquidity and inevitably increase risk.

We applaud current regulators for listening to public feedback and seeing the need to revisit Basel III. Whether the proposal is rewritten in part or entirely, it is imperative that any changes are viewed through the lens of preserving the viability of the central clearing ecosystem. On this point in particular, regulators must “get it right.”

Paul Atkins is Patomak Global Partners Chief Executive and former SEC Commissioner, and Jill Sommers is Patomak Global Partners Chair of the Derivatives Practice Group, and former CFTC Commissioner.