When can SMSFs invest in derivatives?

By Grace Ormsby

August 31 2020
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Do derivatives provide legitimate opportunities for SMSFs? A lawyer has weighed in.

Jeff Song, the managing solicitor of Townsends Business and Corporate Lawyers superannuation online services division, has described derivates transactions as including a “broad assortment of instruments such as options, futures, warrants, swaps or Contracts for Difference (CFDs)” and has acknowledged their use as a diversification tool for a number of SMSF trustees.

In a nutshell, Mr Song said there is no law to prohibit this type of investment; however, “SMSF trustees should carefully observe the relevant compliance requirements”.

But what exactly is a derivative?

“In a typical derivatives investment, the investor enters into a contract (which gives rise to certain contractual rights and obligations between the parties) without the investor actually owning the underlying assets that the contract is linked to and derives its value from. The underlying assets can include shares, commodities, currencies and a variety of other asset types,” the lawyer stated.

He also flagged that some ETFs can also be derivates – where the assets held in the ETFs are themselves derivatives.

So, what are the compliance requirements?

Like with any other investment option for an SMSF, investing in derivatives must satisfy the sole purpose test, Mr Song stated.

Secondly, the fund’s trust deed should be reviewed to check whether the deed actually permits derivatives investments.

Thirdly, the lawyer advises reviewing the fund’s investment strategy “to see if the proposed derivatives investment is within its scope”.

“Financial implications of investing in derivatives, including the associated risks with such investment, should be carefully considered and it would be advisable for trustees to seek appropriate financial advice in this regard,” Mr Song added, commenting that it would aid trustees with discharging their general trustee obligations in relation trust investments (including SMSFs) which obligations are incorporated as overarching covenants in the SIS Act.

When is a derivative risk statement required?

According to Mr Song, if the derivatives give rise to a charge over the assets of the fund, there’s an additional need to have a formal derivatives risk statement in place.

While not all derivatives require a charge over its assets as security, when it is required, the terms of the statement must be complied with throughout the investment period.

There are five requirements to a derivative risk statement, the lawyer said, with these set out below:

What policies the trustees will adopt in the use of derivatives;
How the trustees will analyse and assess the risks associated with the use of derivatives;
How the use of derivatives fits in with the investment strategy of the fund;
What restrictions and controls the trustee will put in place to regulate the use of derivatives, particularly taking into account the expertise available to the fund; and
The compliance processes to ensure the controls are effective.

“SMSF auditors are also expected by the ATO to check and ensure that an appropriate statement is in place and that the relevant derivatives investments (and the charge thereby given) are consistent with the terms of the statement,” the lawyer continued.

Even with the above considerations, Mr Song said the issues that could arise through SMSF investment of derivatives listed above are not by any means an exhaustive list.

“A trustee considering such investment should obtain appropriate advice to ensure compliance,” the lawyer advised.

About the author

Grace Ormsby

Grace is a journalist on Momentum Media's nestegg. She enjoys being able to provide easy to digest information and practical tips for Australians with regard to their wealth, as well as having a platform on which to engage leading experts and commentators and leverage their insight.

About the author

Grace Ormsby

Grace is a journalist on Momentum Media's nestegg. She enjoys being able to provide easy to digest information and practical tips for Australians with regard to their wealth, as well as having a platform on which to engage leading experts and commentators and leverage their insight.

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Retirement