How CFDs Work
When you trade CFDs you are required to provide a small percentage of your total exposure, in the form of margin payment. However, your total profit and loss potential is much greater than the amount of margin that you pay. So, if you buy $10,000 worth of BHP CFDs with a margin requirement of 5%, you only need to provide margin of $500 to open the position. If the position moves against you by 10%, you will lose $1,000 or double your initial deposit.
Margin Calls can be required
Depending on the CFD trades you've opened, and how long they are open for, the CFD Provider may require you to pay financing costs. You will incur these financing costs on a daily basis when you keep CFDs on certain underlying assets open overnight. In some cases, particularly if you hold CFDs for a long time, the aggregate of these financing costs may exceed the amount of any profits or significantly increase losses. If the position moves against you, or you allow financing costs to add up, you could lose more than you have deposited. If this happens you will be required to make additional margin payments to cover losses on your open positions. If this is not done your position will be closed and the loss crystallized.
Under current rules a SMSF, cannot borrow (unless under an instalment warrant structure) and cannot place a charge against any SMSF Asset. This then raises the following key issues:
Is there a borrowing, and hence a contravention of the 'No Borrowing" rules with CFDs?
Is there a contravention of the 'No charge over Fund Assets" Law due to the margin requirement with CFDs?
The ATO Responds
The ATO have addressed these issues as follows:
CFDs are not a Borrowing
The ATO have confirmed that "there is no loan between the CFD provider and the SMSF Trustee and therefore no contravention of the prohibition on borrowing by trustees under Super Laws". The requirement to pay a deposit and meet margin calls does not represent a borrowing. These are contractual liabilities to make payments if and when required and are not repayments. The ATO have confirmed that CFDs even though they offer leverage are not Borrowings and hence are not a breach of Super Laws.
There is no Charge over Fund Assets with CFDs
The ATO have confirmed that "the operation of the CFD bank account and the obligation to pay deposits and margins does not create a charge over any assets of the Fund". Under the CFD, the monies in the CFD bank account are the property of the CFD provider and the Fund (investor) has no beneficial interest in the account.
CFDs with CMC Markets
Importantly CFD Investments with CMC Markets (the preferred CFD Providers for ESUPERFUND clients) are allowable SMSF Investments in accordance with the ATO guidelines and do not breach any Super Laws.
Derivatives Risk Statement
Clients who trade Derivatives for their SMSF must prepare a Derivatives Risk Statement in accordance with current Superannuation Laws.
The Derivatives Risk Statement details the reasons for the use of derivatives by the SMSF, along with an analysis of the risks involved within the SMSF Investment Strategy.
A Proforma Derivatives Risk Statement can be found here which you can adopt or modify as required for your SMSF.