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CFDs
ATO decision opens doors to DIY super investors
Toni Case - March 2007

DIY super investors can now use CFDs to insure against market falls, but critics of CFDs shun the merits of the move. Toni Case reports.

Super funds have been investing in derivatives for years, but the recent decision by the Australian Tax Office (ATO) to allow self-managed super funds (SMSFs) to invest in contracts for difference (CFDs) has reignited anger in the anti-CFD brigade.

Opponents of CFDs, who are justly concerned that this relatively new and increasingly popular derivative could be attracting the wrong crowd, heap criticism at the ATO’s decision. Since CFDs are a highly leveraged instrument – a $10,000 deposit can access over $100,000 of shares, for instance – a SMSF investor can be at risk of loss by unexpected price swings.

The critics highlight ASIC’s candid comments on their consumer website FIDO, notably, that CFDs are like borrowing to gamble – and “because of this borrowing, it’s much riskier than a flutter on the horses or a night at the casino.” They say that CFDs have no place in a SMSF.

Jonathan Barratt, managing director of Commodity Broking Services says that, based on his experience, CFDs are no more ‘gambling’ than trading shares. If used correctly - and it’s worth emphasising here that CFDs don’t have to be leveraged to the hilt - as a hedging tool the product is second to none.

It’s ASIC’s role to play the devil’s advocate. Unskilled sharemarket punters shouldn’t be investing in CFDs, and, understandably, ASIC wants to throw them off the scent.

But investing in other derivatives such as options and warrants is nothing new to the canny DIY super investor. Writing call options to generate income or buying put options as a protection against market falls have been used by the super industry for years. In fact, many super funds – the type that mum and dad buy off the shelf – regularly invest in derivatives.

It could be argued that if super funds controlling money on behalf of thousands of members regularly invest in derivatives, then SMSF trustees – at the helm of their own fund’s destiny – should be able to make prudent decisions about their own fund. And if CFDs are their tool of choice, then is this so bad?

Barratt believes that the shorting capabilities of CFDs make them especially suitable for a SMSF. (Shorting is the act of selling a security that you don’t own with the intention of buying it back at a lower price in the future to profit from the price fall). In actual fact, Barratt argues that SMSFs should have some form of hedge against market falls, and that CFDs are the perfect instrument to achieve this. “CFDs are the insurance in a SMSF,” he says.

The issue with CFDs is that, unlike their more complex cousins – options and warrants – CFDs are simple. They are simple to understand and simple to trade. Over the past five years, CFD providers have advertised to bring this to investors’ attention – and their hard spend is generating numbers. Anecdotal evidence suggests that CFDs today claim upwards of 5% of the market.

Rather than criticising the ATO decision per se and angling for a blanket ban on CFDs in SMSFs, the CompareShares.com.au response is to highlight that CFDs are deceptively simple. While the underlying mechanics are easy to understand, the market is not. To successfully invest in CFDs, the SMSF trustee must possess an advanced understanding of the market and their tools of trade.

With over 300,000 SMSFs holding more than $250 billion in assets, the news has put a skip in the step of the CFD community. The ATO decision gives more clarity to a once cloudy issue: albeit, many DIY super investors were investing in CFDs prior to the decision anyway.

“Until recently in the absence of a ruling clients would seek their own legal and tax advice on whether they can use CFDs as part of their SMSF,” says Tamas Szabo, head of trading at IG Markets. “Our experience has been that our clients come within or bring themselves within the ATO framework,” he adds.

The ATO investigated two separate scenarios in relation to whether a SMSF that invests in CFDs is effectively using borrowed funds to do so. Borrowing is prohibited under the Superannuation Industry (Supervision) Act 1993, and is the reason why DIY super investors can’t use margin lending in a SMSF or buy properties on credit.

The ATO concluded that provided a SMSF does not deposit fund assets with the CFD provider as security against their obligations to pay deposits or margins, then there is no loan between the CFD provider and the SMSF trustee.

In short, provided that a SMSF trustee deposits cash into a CFD bank account rather than fund assets, then they don’t contravene the prohibition on borrowing by trustees in section 67 of the SISA.

Clearly, there is more to it than that. SMSF trustees must ensure that investing in CFDs concurs with their fund’s investment strategy, that they have adequate risk management procedures in place and they aren’t trading CFDs for speculative gain. But as long as the legal and compliance side is in place, the ATO doesn’t see a reason to complain.

Financial markets are not what they used to be, and the rise of CFDs is a fine example of the new era for investors. CFDs can access markets globally – across shares, commodities, foreign exchange and indices – all from the same computer and driven by little more than an internet connection. The rise of the internet and the development of sophisticated software applications are at the root of these product advances.

The changing of the guard will always meet with opposition. But we must remember that what we regarded as high risk in the past is now everyday practice. For instance, taking out a loan to buy a property was once regarded by many as a big step. Today, million dollar mortgages on the family home are not uncommon.

Contracts for Difference (CFDs) are a natural evolution of the industry, and whether established interests like it or not, are here to stay. Later this year the Australian Stock Exchange (ASX) in cohorts with the Sydney Futures Exchange (SFE) will launch the world’s first CFD exchange. It’s clearly taken the view that CFDs have become too big to ignore.

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Toni Case is the editor of CompareShares.com.au and is Australia’s first journalist to specialise on Contracts for Difference (CFDs). She was a staff writer for Shares, Personal Investor and Asset Magazines, and today is a regular columnist with the Australian Financial Review. She is a qualified financial adviser, and has an Economics (Honours) degree from Sydney University.