The emergence of non-fungible tokens could create issues for SMSF investors as there is little regulatory intervention at present, according to an educator.
SuperGuardian education manager Tim Miller posited that investing non-fungible tokens (NFT) could raise more regulatory issues for SMSF than cryptocurrencies because there is little understanding around them.
An NFT is a financial security comprising digital data stored in a blockchain, a form of distributed ledger. The ownership of an NFT is recorded in the blockchain, and can be transferred by the owner, which allows NFTs to be sold and traded.
Mr Miller noted to SMSF Adviser that younger SMSF investors who are potentially more digitally savvy than older trustees are particularly attracted to NFTs as they hunt for investments that meet their lifestyle.
“But have the regulatory boundaries kept up with the emergence of these sorts of investments?” Mr Miller questioned.
He equated NFTs to digital artwork, and pointed out that there are stringent regulations and legislation that stipulate how SMSFs can invest in artwork.
“Now the question is, do NFTs fall under that definition, or don’t they? This is something that hasn’t really been clearly or adequately defined by the regulator,” he told SMSF Adviser.
“It’s quite speculative as to whether an NFT is a collectible or a personal use asset, and most people make the assumption that it is.
“In this case, it would suggest that if it is considered a collectible and personal use asset, then it’s almost impossible for an SMSF to invest in it because questions arise over how they meet all their obligations like storing it and providing proof of storage requirements that you would do with normal artwork.”
Mr Miller made the comments ahead of the SMSF Adviser Technical Strategy Day 2022, which will be held in Melbourne, Sydney, and Brisbane in October.
At the conference, he will present a session on non-standard investments like cryptocurrencies, digital and alternative assets even as regulatory scrutiny and fund auditors grow, the compliance hurdles SMSFs could face when investing in digital assets, and the behaviours associated with digital assets that are currently under the regulator’s radar.
Meeting the regulatory requirements
Mr Miller urged trustees to do their due diligence and ensure that they are following regulatory requirements such as separating NFT assets in their SMSFs from any personal NFT investments.
“Also, remember that an NFT requires SMSF trustees to have cryptocurrency to buy it so they inevitably are going to have to be investing in cryptocurrency in their SMSF to be able to invest in the NFT,” Mr Miller said.
“Therefore, trustees have to go through the process of getting the regulatory requirements right from the cryptocurrency point before going down the path of investing in the NFT.”
Another issue SMSF trustees need to be cognisant of is the sole purpose test, and being able to prove that they are investing in NFTs to fund their retirement, particularly because “it is not necessarily a reliable market for NFTs”, Mr Miller said.
“It’s fairly difficult for me to suggest that trustees can prove whether they are investing in NFTs for retirement income purposes or for status purposes,” Mr Miller warned.
“It stems into the sole purpose test requirement that you’re providing for the member’s retirement benefit as opposed to you incurring that benefit from being the presumed owner of that particular NFT.”
Defining fund objectives
Mr Miller underscored that non-standard investments attract greater scrutiny around sole purpose test requirements.
As such, when designing investment strategies for clients interested in them, they must define the fund’s objective, what it is attempting to achieve, and how these investments could meet those objectives, he suggested.
“Then they need to figure out what documentation they need to make sure that their investment strategies align with those objectives so that we can work through the requirements when it comes to the fund’s audit process,” he said.
Alongside this, having an appreciation for the fund’s investment strategy requirements, considering the risks associated with these investments, and ensuring that the trustee has sufficient liquidity to discharge their liabilities is critical, Mr Miller emphasised.
“It’s about doing your due diligence to make sure that you’re using the right vehicle to invest in NFTs or cryptocurrencies and ensure you still have access to your money if you choose to sell,” he concluded.
To hear more from Tim Miller about how advisers can enable the adoption of alternative assets for clients increasingly interested in them while mitigating new risks, come along to the SMSF Adviser Technical Strategy Day 2022.
It will be held on Thursday 6 October at Crown Towers in Melbourne, Friday 14 October at the Four Seasons Hotel in Sydney, and Wednesday 26 October at the Brisbane Convention and Exhibition Centre.