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Buyback Transactions

Buyback Transactions

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1. What is it?

Buyback Transactions or Repo Operations are those where the seller has the commitment to buy back the bonds they “lent” to the buyer in a future transaction with a preset date, and paying a preset profit. Buyback transactions occur when the commitment is made to reverse the transaction currently taking place – in other words, buying back if a sale was made, selling back if a purchase was made. Notably, the buyback transaction is one where a loan is being made from one party to the other, to which the guarantee, or financial backing, is a bond.

Banks buy and keep bonds in their portfolios. They might offer to sell this bond to a person, with a preset commitment to buy it back in a preset amount of time. This would almost be like a bank asking a client for a loan and giving, as financial backing, a bond from their portfolio. This way the bank hasn’t truly sold the bond, and the client doesn’t really own it – it’s on loan for a preset period. And, at the time of the buyback (or sell back), there is no room for negotiation and no option to the bond holder not to fulfill the transaction. If this was an actual buy and sell transaction, there would be no preset commitment to repurchase it.

Buyback transactions are restricted to only a few types of bonds. They can only be conducted for under the following circumstances:

  • Treasury bonds (public bonds) or Central Bank Securities;
  • National Treasury securitized bonds;
  • Agrarian debt bonds issued by the Brazilian National Institute for Agrarian Reform (INCRA);
  • State and city government securities;
  • Bank Deposit Certificate
  • Bank credit notes (CCBs, in Portuguese) and certificates representing bank credit notes (or CCCB, in Portuguese);
  • Bills of Exchange from financial institutions (LC, in Portuguese) and Mortgage Backed Securities (LH, in Portuguese);
  • Real estate credit bills and notes (LCI and CCI, in Portuguese);
  • Debentures and debenture bills;
  • Commercial bills;
  • Certificates of real estate receivables (CRI, in Portuguese);
  • Rural produce instruments with financial liquidation;
  • Certificates of Agribusiness Credit Rights, Agribusiness letters of Credit and Agribusiness Credit Receivable Certificates (respectively CDCA, ICA and CRA, in Portuguese);
  • Export receivables notes and bills (respectively CCE and NCE, in Portuguese);
  • Other specific bonds that eventually receive authorization from the Brazilian Central Bank.

On buyback transactions at least one of the parties involved should be a commercial bank, multiservice bank, investment bank, development bank, credit, funding and investment company, brokerage house, broker dealer or the Caixa Econômica Federal (the Brazilian Federal Savings and Loan Bank). Only these entities are authorized to conduct this type of transaction.

Trading of buyback operations is done over the counter and has a mandatory registration with the SELIC rate (the Brazilian prime rate), CETIP (Central de Custódia de Títulos Privados, or Private Bond Custody Center, in loose translation. This is an open society company that offers services to the financial market in Brazil) or the Clearing House at the Brazilian Stock Exchange (BM&F).

The main reasons that would drive an institution to trade buyback transactions are:

1) Credit: a lot of times banks need a fast inflow of cash. Smaller banks cannot achieve that by simply issuing a Bank Deposit Certificate (or CDB, in Portuguese) because creditors demand solid guarantees. So they opt for buyback transactions. If the bank doesn’t exercise the repurchase at the due date, the bond is automatically transferred to the holder.

2) Cost: banks may issue CDBs. But, if they trade on buyback transactions with safer bonds (such as public bonds), they may raise money on lower costs: the interest rate payable by the bank can be lowered because the financial backing is safer.

3) Opportunity: the bank owns a high interest rate bond and, instead of selling it, chooses to “rent it out” for a lower rate and make money on the difference between the rates.

4) Not to pay the Credit Guarantee Fund (FGC, in Portuguese): a bank wishes to raise money but doesn’t wish to pay the FGC. And buyback transactions aren’t guaranteed by the FGC.


2. Profitability

Profitability on buyback transactions is, in most cases, linked to the Interbank Deposit Rate. It’s defined at the time of the purchase and may be prefixed or post-fixed. Use of exchange rate adjustment clauses for buyback transaction contracts is forbidden, with the exception of trades based on exchange rate linked bonds.


3. Risks

The risks for buyback transaction investments are low considering the traded bond is itself the investment guarantee. As an example, let’s consider a person wishing to invest in this type of bond and trading based on a public bond. If a problem occurs with the trading bank, or it goes bankrupt, the title is transferred to the buyer – and the person can cash the bond to receive their investment back. Caution is advised in buyback transactions involving private bonds – the risk of those bonds should be considered independently, before entering the transaction.


4. Taxation

For buyback transaction, the income tax decreases with the longevity of the contract:

  • Investments of up to 180 days: 22,5% (only over the profits)
  • Investments from 181 to 360 days: 20% (only over the profits)
  • Investments from 361 to 720 days: 17,5% (only over the profits)
  • Investments over 720 days: 15% (only over the profits

Payment of the income tax due is withheld by the bank and automatically transferred to the IRS. At the due date you should receive credits equivalent to the full amount of profits minus the due income tax. Asides from this, other charges might only be bank related charges.

There is also the tax on financial transactions (IOF), as shown below. However, there are exemptions for some backed securities, such as bonds, mortgage-backed securities, Banknotes, Agribusiness Letters of Credit, Credit Rights Certificate in Agribusiness and Agribusiness Receivables Certificates (Decree 6.306 updated until the 8.231 decree of 2014).

Days passed from the investment date Taxable stake of profits (%)
1 96
2 93
3 90
4 86
5 83
6 80
7 76
8 73
9 70
10 66
11 63
12 60
13 56
14 53
15 50
16 46
17 43
18 40
19 36
20 33
21 30
22 26
23 23
24 20
25 16
26 13
27 10
28 6
29 3
30 0

5. How it works

Although this type of operation is more common between banks and companies, normal persons may also choose this as an investment. To do so one must only have a bank account with their bank of choice for the investment. All details of the contract should be available at the chosen bank – commonly enough, this type of transaction is linked to the Interbank Deposit Rate, as mentioned, and therefore has a daily liquidity.


6. Types

There are two kinds of buyback transactions:

1. Sale with a promise of buyback or purchase with a promise of back sale:

  • On the same day, overnight or over one day (usually the last one is conducted only between companies);
  • With or without free trading of the bonds;
  • Combined (buyback to the back sale, allowing for Central Bank bond loans).

2. Long term*:

  • For sale or purchase;
  • Uncovered or not;
  • Combined to cash back sale or back purchase

*Only between financial institutions;
*Only based on treasury bonds or in a mediating environment;
*Based on bonds to be auctioned: if treasury bonds, in a previously announced offer, with a minimum position of 51% of the whole offering and in the same date as the liquidation date.


7. Advantages

  • A good way to diversify one’s portfolio;
  • One may invest without holding ownership of the bond;
  • The bond itself guarantees the transaction.
  • The Credit Guarantee Fund guarantees buyback transactions which have as their object bonds issued after March 8, 2012 by related company.

8. Disadvantages

  • Not guaranteed by the Credit Guarantee Fund with bonds issued before March 8, 2012 by related company;
  • Doesn’t pay very high profits because, usually, it pays less than the bond itself;
  • It’s burdened by income tax.

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