Navigating emerging compliance breach hurdles facing crypto in SMSFs

From an auditors’ perspective, she noted that it is more difficult where the trustee decides to invest in digital assets to trade and not just hold the asset.

“Apart from going through all those extensive investment reports, the main risk SMSFs face here from a compliance perspective is identifying the other party in the transaction which could relate to a compliance breach at the end of the day,” Ms Banton said at the recent CA ANZ conference.

“We need to look at the transaction very closely and ask whether there’s a related party. SMSFs must consider if the fund has lent money or provided financial assistance to a member or a relative. We also need to ask whether trustees are trying to pass off crypto, for example, as a contribution because it’s a digital asset, not cash.”

With the continued development of different types of lending products being seen in the crypto market, SMSFs must also consider situations if the fund has effectively borrowed money, according to Ms Banton.

These can be situations where SMSFs can lend or exchange crypto to another lender and get fiat currency in return in order to buy more crypto.

“It is really no different from mortgaging the fund’s property and investing the cash in another asset, and this can lead to a major risk because it leads to the danger of whether there has been a charge given over the assets of the fund,” Ms Banton noted.

“Now, this point is really important because one of the things we’re seeing in the crypto space is the development of products that allow crypto to be hedged against standard currencies or another crypto.”

Where a fund traditionally invests in a derivative, Ms Banton said that from an audit viewpoint, it could be acceptable to have a separate derivative risk strategy because a charge is given over fund assets.

“But these exemptions only apply to transactions being undertaken on approved bodies being domestic and foreign exchanges and clearing houses, which are all listed in Schedule 4 of the SIS regulations,” she explained.

“One of the things I can categorically tell you is there are no cryptocurrency exchanges listed in Schedule 4. So if a fund’s trading in crypto derivative products, it’s going to be a breach of Reg 13.14. 

“The reason is there’ll be a charge given over the assets of the fund which may be in the exchange or in the wallet because the trustee will be undertaking hedging activities or making margin deposits to the exchanging crypto to eliminate that counterparty risk.

“Please be aware that there are some crypto exchanges, which are quickly developing these sophisticated unregulated financial instruments which are going to result in compliance breaches for funds if they take them up.”