You may be wondering whether investing in Contracts for Difference (CFDs) is permitted in superannuation funds and how to invest in CFDs.
You probably heard that with $1000 you could potentially control a $200,000 portfolio of shares? S&P/ASX 200 accumulation index grew 32% in 2009 and the $200,000 portfolio would have made $64,000 profit. This did not involve stock picking, just using a broad Aussie shares index. Does this sound like too good to be true?
It is becoming increasingly popular for SMSFs to use leverage in order to magnify returns by investing in derivatives such as Contracts for Difference (CFDs). ATO defines CFDs as financial products that are synthetic in nature which allow investors to use the movement in share prices and other instruments such as stock indices, stock options, future contracts without owning the underlying product.”
The ATO sates that a SMSF should only enter into derivatives transactions, if hedging is the aim and not speculation; and the SMSF has a risk management strategy (RMS) in place.
The ATO Interpretive decisions released on 29th March 2007 tries to distinguish between the two different methods of transactions which are available in the market. One type requires the investor to place an amount on to the provider as receiving a deposit and the other type requires the financer to pledge the investor’s assets.
Below is an outline of the two types of Contracts for Difference (CFDs).
CFDs Type 1
The ATO’s interpretative decision states that when hedging is the goal and there is no pledging of assets, investing in CFD’s by a SMSF will abide by the regulations established by the SIS Act.
The ATO states their reasoning for this as because no loan exist with the provider and the SMSF trustee and therefore not breaking the prohibition on borrowing by trustees in section 67 of the SISA. The requirement to pay a deposit and calls on margins are met. They are rather contractual liabilities to make payments if and when required and are not repayments. The obligations in relation to CFDs are distinguished through a broker's margin account in relation to SMSFs purchasing securities, which does not follow the regulations of the SIS Act in regards to borrowing.
Maintaining an account for CFDs for the payment of deposits and margins does not create a charge over any assets of the fund. The parties are relying on the contract and not on the interst of the security to be created by the contract. Under this vehicle, the funds in the CFD account are the property of the provider of the CFD with the fund (investor) having no beneficial interest in it. (Trustees need to examine individual product disclosure statements in order to ensure no charge has been made over an asset as prohibited by SIST under regulation 13.14 requirements of these regulations are adhered to.)
The investment is in accordance with the fund's investment strategy as required under paragraph 52(2)(f) of the SIS Act and regulation 4.09 of the SIS Regulations.
CFDs Type 2
ATO’s interpretative decision 2007/57 states that immaterial of the fact that hedging may be the sole purpose for investing in CFD’s, if provider requires the investor to allocate other collateral when SMSFs invest in CFDs will be considered not meeting the rules of the SIS Act. Should this occur the trustee of a SMSF has contravened the SIS Act according to subsection 34(1).
ATO’s reasoning for this decision on CFDs in SMSF is:
The trustee and the CFD provider entered into a separate written agreement under which fund assets were deposited with the CFD provider in fulfillment of the fund's obligation for margin calls. The SIST Regulation 13.14 prohibits a charge over from being granted by trustees, or in relation to the fund’s assets. This regulation is an operating standard for regulated superannuation funds that falls under SISA. Subsection 34(1) of the SISA requires that the operating standards are complied with at all times.
SIS Regulation 13.15A, which allows trustees to give a charge over assets of funds in relation to options and futures contracts in accordance with what an approved body as laid out and in accordance with the fund's derivatives risk statement, does not apply. It is not a futures or options contract and the charge was not given in relation to the regulations laid down by the appropriate body. In this instance a trustee may have broken regulation 13.14 as well as the SIS Act subsection 34(1).
In Conclusion - using derivatives and CFDs in SMSF
As a SMSF trustee prior to making an investment in CFDs the trustee must consider the following:
- Does the trust deed allow for CFD's and professional advice needs to be obtained to review the SMSF deed for potential issues;
- If derivative investments like CFDs are acceptable the trustee must only deposit cash as margin; and
- There must be an RMS (Risk Management Statement) in place.
When SMSFs do not comply with the regulations your auditor may lodge a contravention report meaning that during an audit your fund may be found to be non-complying.
What are CFDs?
CFDs are based on wholesale futures instruments. They are highly leveraged trading products that can augment the gains or losses of traders that only put down 1% or even less of their trading exposure.
Equity based CFDs allow investors to take a short in the event that they feel a listed stock will drop in value or a long position if they predict a stock to increase in value.
By committing your assets to CFDs you are taking large risks. For example by taking a long position with a CFD, you are betting on an upward movement on the underlying stock price. You are leveraged 100 times in an index CFD so by putting down 1%, you've got to be pretty certain you've got the resources to cover a fall. For example, an investor who puts a $1000 bet on the ASX200 Aussie shares index rising would incur a loss of $40,000 (plus fees and interest) if the index fell by 40%. Which is not impossible, as many saw in 2008-2009 financial crises. Speak to your financial adviser to learn more about the dangers of CFDs.
iMoney Wealth Management feels the only genuine purpose for using CFDs in superannuation funds is hedging existing positions. Ask your adviser online
if you have any questions about superannuation or SMSFs.