THE SHORT ANSWER
A cost of issuance fund holds bond proceeds set aside to pay the issue's own expenses, from the underwriter's discount through bond counsel and rating agency fees. Because the account holds funds pending payment, its investment question is short-dated liquidity, and money market funds under SEC Rule 2a-7 are one instrument family whose limits are written in days. Which federal temporary period its balances fit is a question for bond counsel.
A cost of issuance fund is invested around a payment calendar rather than a project calendar: the account holds money pending payment of the costs of selling the issue, so its investments are lined up to be available on the deal's payment dates.
It is one of the bond funds, alongside the construction fund, the reserve funds and the debt service funds.
This page covers what the fund pays, how long the money sits, and the money market and same-day options that fit the window.
What does a cost of issuance fund pay?
It pays the costs of issuance, which the MSRB glossary defines as the expenses associated with the sale of a new issue of municipal securities, including the underwriter's discount and financial advisory, bond counsel, other counsel and rating agency fees, and other expenses.
When the issue finances them, the money that pays them is sale proceeds: Treasury Regulation §1.148-1(b) defines sale proceeds as any amounts actually or constructively received from the sale of the issue, including amounts used to pay underwriters' discount or compensation and accrued interest other than pre-issuance accrued interest.
The account also has a job in the issue's construction-fund arithmetic, because 26 U.S.C. 148(f)(4)(C)(vi), as implemented in Treasury Regulation §1.148-7(i), computes available construction proceeds as the issue price plus earnings on it and on certain reserve funds, reduced by the issue price placed in a reasonably required reserve or replacement fund and by the issuance costs financed by the issue.
Issuance costs financed by the issue therefore sit outside available construction proceeds, the base the 2-year construction exception measures for a construction issue, which is treated as meeting rebate if at least 10 percent is spent within 6 months, 45 percent within 1 year, 75 percent within 18 months and 100 percent within 2 years.
How long does the money sit in a cost of issuance fund?
Until the costs are paid: the MSRB glossary describes a costs of issuance account as holding funds pending payment, so the account's clock is the schedule on which the deal's payments fall.
GFOA's list of typical horizons by fund type assigns the construction fund 12 to 36 months and the capitalized interest fund 6 to 18 months, and our review of that list found no range given for the cost of issuance account.
The federal tax clock depends on the issue: under Treasury Regulation §1.148-2(e)(2)(i), net sale proceeds and investment proceeds reasonably expected to be spent on capital projects get a 3-year temporary period from the issue date if the issuer reasonably expects to meet the expenditure, time and due diligence tests, while under §1.148-2(e)(7) gross proceeds not otherwise eligible for a temporary period qualify for 30 days beginning on the date of receipt.
| Proceeds | Temporary period | Where the rule is |
|---|---|---|
| Net sale and investment proceeds reasonably expected to be spent on capital projects, if the expenditure, time and due diligence tests are reasonably expected to be met (not refunding issues) | 3 years from the issue date | Treas. Reg. §1.148-2(e)(2)(i) |
| Gross proceeds not otherwise eligible for another temporary period | 30 days from receipt | Treas. Reg. §1.148-2(e)(7) |
| Investment proceeds | Generally 1 year from receipt | Treas. Reg. §1.148-2(e)(6) |
Earnings carry their own window: investment proceeds are amounts received from investing proceeds under Treasury Regulation §1.148-1(b), so interest the account produces while it waits counts as investment proceeds once received, and those proceeds fall under the 3-year period where it applies and otherwise generally get the 1-year period.
Whether a particular account's balances fit one of those windows, and what happens when one runs out, is the subject of the temporary periods rules, and the classification belongs to bond counsel.
GFOA's recommendation on duration sets the practical bound: keep the investment duration no longer than the expected drawdown schedule and revisit the schedule periodically, and for this account the drawdown is the payment list itself.
What money market and same-day liquidity options fit a cost of issuance fund?
Money market funds under SEC Rule 2a-7 are the instrument family whose limits are written in days, and a government money market fund under the rule invests 99.5 percent or more of its total assets in cash, government securities and/or repurchase agreements that are collateralized fully.
Government and retail money market funds may use amortized cost and/or penny rounding to keep a stable price per share, which is an accounting method the rule provides rather than a guarantee.
| Rule 2a-7 constraint | Level | Citation |
|---|---|---|
| Government fund assets in cash, government securities, fully collateralized repos | 99.5% or more | 17 CFR 270.2a-7(a)(14) |
| Daily liquid assets floor | 25% of total assets | 17 CFR 270.2a-7(d)(4)(ii)-(iii) |
| Weekly liquid assets floor | 50% of total assets | 17 CFR 270.2a-7(d)(4)(ii)-(iii) |
| Maximum remaining maturity of any instrument | 397 calendar days | 17 CFR 270.2a-7 |
| Weighted average maturity ceiling | 60 days | 17 CFR 270.2a-7 |
| Weighted average life ceiling | 120 days | 17 CFR 270.2a-7 |
The liquidity floors stand at their post-2023 levels, and the daily minimum does not apply to tax-exempt funds.
Rule 2a-7 defines a retail money market fund as one with policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons, so retail funds are limited to natural persons and a government issuer investing bond proceeds would be weighing institutional or government classes instead.
The SEC's July 12, 2023 reforms then reset the operating rules in ways that matter for money that must be available on a payment day: they raised minimum liquidity requirements, removed the ability to impose redemption gates, and removed the link between liquidity fees and weekly liquid asset thresholds.
Under the amendments, institutional prime and institutional tax-exempt funds must charge a liquidity fee when daily net redemptions exceed 5 percent of net assets, unless the fund's liquidity costs are de minimis, and that mandatory fee does not reach government money market funds.
One definitional point sits underneath the fund choice: Treasury Regulation §1.148-1(b) says an open-end regulated investment company, such as a mutual fund, is not a commingled fund, while a commingled fund otherwise means a fund holding gross proceeds together with more than $25,000 of other amounts invested collectively.
What that distinction changes for an issue's arbitrage position is arbitrage-file work, and the money market funds for bond proceeds page takes the fund types one by one.
Which of these an issue may hold turns on its bond contract and state law, covered under permitted investments, and the determination belongs to bond counsel.
Who decides what a cost of issuance fund may hold?
The bond contract decides what the fund may hold: the MSRB glossary defines permitted investments as the instruments in which bond proceeds or other funds may be invested under the bond contract, and state law and the federal arbitrage rules then apply on top of that.
GFOA recommends an investment policy with specific provisions for bond proceeds, ones that ensure legal and regulatory requirements are met, fair market value bids are received when required by tax law and state or local laws, and issuer objectives are attained.
Where an issue has no indenture, GFOA says the policy should list permitted investments, which may be a subset of those for operating funds.
What a policy should cover for proceeds generally is the subject of the investment policy guide, and the final legal and tax conclusions on any issue belong to bond counsel and tax counsel.
For a live issue, mGIC's reinvestment advisory reads each fund's objectives, permitted investments, draw schedule, credit terms, market conditions and timing, and the cost of issuance account is part of that map.
mGIC is an independent, SEC-registered municipal advisor and Bidding Agent: it sells no proprietary investment product and acts as no principal in the investments it evaluates, and its record is more than $60 billion in bond proceeds invested and swap notional executed across more than 1,000 transactions for issuers in more than 40 states, with a reinvestment focus since 2002.
Where a fund is already invested, mGIC's free reinvestment review reads the position against the fund's objectives and permitted investments, and it starts from a no-obligation conversation.
When an investment does go to bid, mGIC's fee is paid by the winning provider rather than the issuer, at or below the safe-harbor maximum in the Treasury arbitrage regulations, and it is disclosed.
Final determinations about what an issue's documents permit and how the arbitrage rules treat a particular account belong to bond counsel and tax counsel.
Frequently asked questions
Does money in the cost of issuance fund count toward the construction spending tests?
Under 26 U.S.C. 148(f)(4)(C)(vi), available construction proceeds are computed as the issue price plus earnings on it and on certain reserve funds, reduced by the issue price in a reasonably required reserve or replacement fund and by the issuance costs financed by the issue. The reduction is for issuance costs financed by the issue rather than for an account balance, and how a specific cost of issuance account is treated belongs to bond counsel.
Do the mandatory liquidity fees apply to government money market funds?
No. The SEC's July 12, 2023 amendments require institutional prime and institutional tax-exempt funds to charge a liquidity fee when daily net redemptions exceed 5 percent of net assets, unless liquidity costs are de minimis, and government money market funds sit outside that mandatory fee. The same reforms removed the ability to impose redemption gates.
Are money market fund shares a commingled fund under the arbitrage rules?
No. Treasury Regulation §1.148-1(b) says an open-end regulated investment company under section 851 is not a commingled fund, while a commingled fund otherwise means a fund holding gross proceeds plus more than $25,000 of other amounts invested collectively. What the distinction changes for a specific issue is a tax counsel question.
Do a fund's administrative costs count when proceeds sit in a money market fund?
For a publicly offered regulated investment company or a widely held external commingled fund, Treasury Regulation §1.148-5(e)(2)(ii) counts all reasonable administrative costs, including indirect costs, as qualified administrative costs. Widely held requires, among other tests, more than 15 unrelated investors on average, at least 16 of whom keep at least the lesser of $500,000 or 1 percent of the fund, and whether a particular fund meets the test is fact-specific.
Sources
- MSRB Glossary of Municipal Securities Terms, 3rd ed. (Aug. 2013)
- 26 CFR 1.148-1, Definitions (eCFR)
- 26 CFR 1.148-2(e), temporary periods (eCFR)
- 26 U.S. Code § 148, Arbitrage (Cornell LII)
- GFOA, Investment and Management of Bond Proceeds (approved Mar. 4, 2022)
- SEC Press Release 2023-129, money market fund reforms (July 12, 2023)
- 17 CFR 270.2a-7, money market funds (eCFR)
- 26 CFR 1.148-5(e)(2)(ii), qualified administrative costs (eCFR)
- 26 CFR 1.148-7, available construction proceeds and the spending schedule (eCFR)
This page is general educational information about municipal finance and federal and state rules as of the date shown. It is not legal, tax or investment advice, and it is not a recommendation about any particular investment. Product availability, legality and suitability depend on the issuer, jurisdiction, governing documents and transaction-specific facts. Final legal and tax determinations remain with the issuer's bond counsel, tax counsel and other advisors.
