Introduction
On August 18, the Hyperliquid Policy Center along with trade[XYZ] formally requested that the U.S. Securities and Exchange Commission (SEC) develop a regulatory framework for perpetual contracts related to companies before their initial public offerings (IPOs). This joint submission has been included in the SEC’s public IPO modernization docket, which records ongoing discussions about updating IPO regulations. It’s important to note that simply posting the letter indicates receipt by the SEC but does not imply endorsement of the proposed ideas or given authority for the products discussed.
Proposed Financial Instrument
The proponents introduced a novel financial instrument which they term an Initial Public Offering Perpetual (IPOP). This product would allow investors to gain cash-settled price exposure to a company approaching its public listing. However, buyers of IPOP contracts would not receive shares, voting rights, allocations for the IPO, or any claims against the issuer.
The 15-page letter urges both the SEC and the Commodity Futures Trading Commission (CFTC) to clarify whether these equity-linked perpetual contracts should be classified as security futures or as security-based swaps. This classification is crucial because it determines the corresponding registration procedures, trading platforms, clearing methods, and margin requirements.
Guidelines and Recommendations
In their submission, the groups proposed guidelines around product disclosures, the criteria for listing eligibility, access for investors, and measures for maintaining market integrity. Their recommendations include:
- Providing detailed information regarding funding rates, leverage, liquidations, and settlement procedures.
- Clarifying that holders of IPOP contracts would not be considered equity owners of the underlying assets.
- Emphasizing that American investors should have the opportunity to engage with these pre-IPO perpetual contracts.
Market Examples and Performance
Recent examples highlight the potential benefits of such financial instruments: Cerebras Technologies saw its valuation rise by 89% after its IPO, followed by SK Hynix and SpaceX at 14% and 11% respectively. Notably, the pricing signals appeared on the Hyperliquid market before actual trading commenced, illustrating the potential for IPO modernization to leverage market signals for issuers.
The groups suggested that IPOP contracts could be restricted to a specific timeframe after a company publicly files its registration, with clearly defined oracle and settlement procedures disclosed in advance of trading.
Ensuring Market Integrity
In order to ensure market integrity, proposals included:
- Establishing audit trails.
- Implementing conflict of interest safeguards.
- Prohibiting trading by deployers or their affiliates while in possession of nonpublic information.
- A phased approach for introducing the product, which could place limitations on leverage and position sizes before full access is granted to retail investors.
Trade[XYZ] and Market Challenges
Trade[XYZ] noted that it has already executed five IPOP markets associated with companies like Cerebras, Quantinuum, SpaceX, SK Hynix, and ChangXin Memory Technologies, with these markets open for brief periods ranging from one to 25 days leading up to the official listings. Data from Trade[XYZ] indicated that the final prices of these contracts before trading commenced remained very close—within 0.44% to 7.23%—to the initial opening prices of the relevant stocks.
However, instances were noted whereby U.S. offerings listed as much as 38.4% lower than the IPOP levels noted a day prior. These findings support the assertion that ongoing trading derivatives could offer issuers and underwriters an independent gauge of market demand, although the SEC has not confirmed these performance claims and the limited data points raise questions about broader applicability.
Regulatory Landscape and Future Considerations
The proposal comes in a regulatory landscape characterized by ambiguity, as evidenced by a recent case involving SpaceX which did not authorize an IPOP contract despite its trading. Notably, pricing for perpetuals is influenced by market deployers, making robust pricing practices essential, especially given that private companies may lack consistent market prices before their IPOs.
Trade[XYZ] faced challenges when an anomalously low transaction price for SK Hynix impacted its oracle inputs, resulting in an 18% drop in the perpetual contract’s price, which then triggered liquidations. The company later addressed some of the losses, asserting that its oracle operated according to its outlined framework, even though the discrepancy stemmed from an atypical single-share trade. This incident reinforces the call for enhanced oracle policies and market regulations to ensure accurate and reflective pricing in thin markets.
Conclusion
Currently, Trade[XYZ] conducts these transactions in offshore markets, excluding U.S. investors, as no established U.S. framework permits retail traders access to pre-IPO perpetuals as proposed in the request letter. The CFTC had previously instituted a policy for evaluating perpetual contracts on a case-by-case basis, which mentions that equity-based perpetuals require coordinated oversight from both the SEC and CFTC. As both regulatory bodies consider whether cash-settled perpetuals tied to equity securities fit the criteria for security futures, their eventual conclusions will significantly influence the applicability of existing rules to such instruments.
There is no specified timeline for a response to Hyperliquid’s submission, and the SEC is under no obligation to accept the recommendations made within the letter. Possible subsequent measures include discussions among agency staff, solicitations for public commentary, joint regulatory guidance, or formal rulemaking efforts.
