Contracts for Difference – hit the wall
Coverage of the collapse of one of the world’s largest broking houses (triggering margin calls on thousands of CFDs held by Australians) has once again put this product under the spotlight.
What is a CFD?
CFDs are highly leveraged derivative products that can magnify the gains and losses of investors. CFDs are essentially a leveraged bet on future changes in the market price of a share or commodity, or the value of an index or a currency exchange rate.
As CFDs are derivatives, investors do not actually invest in the underlying asset, but rather in a contract whose value is determined by reference to the market price of the underlying asset.
Why the concern?
The financial sector regulator the Australian Securities & Investments Commission (ASIC) has been monitoring the CFD market for some time because of the complex nature of these products and the risks involved.
Investors are attracted to CFDs because of the opportunities they offer and the low initial capital required to commence trading and also the perceived ease of trading. Because of this ASIC has found that the majority of investors do not seek or receive personal financial advice prior to investing.
ASIC is also concerned about the involvement of self managed super funds (SMSFs) with CFDs. An ASIC survey has found that a number of SMSFs were investing in CFDs without fully understanding the risks.
It is therefore vital that SMSF trustees understand the repercussions of investing in CFDs and where SMSFs have poor diversification through a heavy skew to CFDs, they also run the risk of contravening the super laws as an investment strategy that fails to take into account the risks and returns of the fund may be a breach of the rules.
The Australian Taxation Office (ATO) as the regulator of SMSFs released an ATO Interpretative Decision (ATOID) in regards to SMSFs investing in CFDs . The ATOID basically allows the use of CFDs in an SMSF for hedging purposes, as opposed to taking a long position that seeks to profit from increases in the market price of a particular asset.
SMSFs and all investors need to be wary about investing in complex derivative products. ASIC has released a report on CFDs that is useful reading for those interested in CFDs.
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