Under super law, derivative means ‘a financial asset or liability the value of which depends on, or is derived from, other assets, liabilities or indices’. A derivatives contract means ‘an option contract or futures contract relating to any right, liability or thing’.  They are an allowable investment for a SMSF, subject to certain conditions.

Super law outlines very few restrictions on exactly what type of investments Fund Trustees are able to invest in, however the law as how those assets are structured can be very prescriptive. In the case of a Fund’s investment in derivatives the main issue is the fact that some derivative contracts have a margin, or collateral requirement, and hence may fall foul of Regulation 13.14. In other words the Trustee must not give a charge over, or in relation to, an asset of the Fund.

 

Anyone considering derivatives within a an SMSF  should read Regulation 13.15A of the Superannuation Industry (Supervision) Regulations 1994, for some background on the use of collateral and derivatives.

However there is an exception when it comes to derivatives. Regulation 13.15A states that a Trustee may give a charge over an asset of the Fund if:

  • the charge is given in relation to a derivative contract
  • the Fund has in place a derivative risk strategy
  • the charge is given in order to comply with the rules of an approved body (such as options clearing house)
  • the investment to which the charge related is made in accordance with the derivatives risk strategy

It may be concluded therefore that under super law, derivatives are a legitimate and allowable investment for a SMSF providing the above are satisfied.

Other conditions that must be satisfied for a Fund to be able to invest in derivatives include ensuring that the

Fund’s investment strategy (and trust deed) permits the Fund to invest in derivatives.

As mentioned above in relation to regulation 13.15A, a Derivatives Risk Statement, a statement that explains the SMSF’s risk management policies when using derivatives is also required where the Trustees are entering into derivatives contracts where collateral (i.e. margin) is held. This applies for all futures contracts and ‘sell to open’ options contracts.

 

A word from the ATO

The main issue that the ATO (the regulators of SMSFs)  have with Trustees using derivatives in a

SMSF (apart from having all of the above documentation in place) is to be able to show compliance with regulation 4.09 of the super law as below:

 

Regulation 4.09 Operating Standard – Investment Strategy

4.09(2) [Considerations in formulating strategy]

The Trustee of the entity must formulate and give effect to an investment strategy that has regard to all the circumstances of the entity, including in particular:

(a)    the risk involved in making, holding and realising, and the likely return from, the entity’s investments, having regard to its objectives and expected cash flow requirements;

(b)   the composition of the entity’s investments as a whole, including the extent to which they are diverse or involve exposure of the entity to risks from inadequate diversification;

(c)    the liquidity of the entity’s investments, having regard to its expected cash flow requirements; (d)    the ability of the entity to discharge its existing and prospective liabilities.

 

What to do?

Derivatives are a legitimate and allowable investment inside a SMSF. A super Fund might use derivatives for a variety of purposes.  For example derivatives can improve portfolio returns – via more income – or limit potential losses if a Trustee is concerned about the value of an asset falling.

There are however regulatory challenges and any investment by a Fund will require research and careful consideration. Financial advice should be sought prior to considering an investment in derivatives in your SMSF.

 

McQueen Financial Group is a corporate authorised representative of Total Financial Solutions Limited. AFSL No. 224 954, ABN 94 003 771 579. This information is of a general nature only and does not consider your investment objectives, financial situation or particular needs. You should not act on any information in this report without first consulting a professional investment adviser in order to ascertain whether the information and any investment decision is appropriate. This information is believed to be accurate however no warranty of accuracy or reliability is given in relation to any advice or information contained, and neither TFSA or its Representatives and officers, agents or employees of either of the aforementioned shall not be held liable for any loss or damage whatsoever arising in any way for any representation, act or omission, whether express or implied (including responsibility to any persons by reason of negligence).