THE SHORT ANSWER
A bond indenture is the contract between an issuer and a trustee for the bondholders' benefit. It governs investing proceeds by creating the funds and accounts that hold the money, defining the permitted investments each fund may hold, and giving the trustee, often as custodian, the job of holding them. For federal yield-restriction purposes, Treasury Regulation §1.148-5(d)(2) generally requires yield-restricted nonpurpose investments to be valued at present value.
A bond indenture governs the investment of bond proceeds by creating the funds and accounts that hold the money, defining the permitted investments each fund may hold, and giving the trustee, often as custodian, the job of holding them under the contract.
The MSRB glossary defines an indenture as a contract between the issuer of municipal securities and a trustee for the benefit of the bondholders, one that sets out the parties' rights, duties and remedies and the exact nature of the security for the bonds.
Many governmental issues, especially general obligation bonds, may not use an indenture at all, as the same glossary notes, and where there is none the GFOA best practice says the issuer's investment policy should list the permitted investments for proceeds.
Where a revenue financing does use one, the contract's investment provisions govern proceeds in a market SIFMA reports at $4.5 trillion of municipal bonds outstanding as of 2Q 2026, with $473.8 billion of issuance in 2026 through September and an average of $17.2 billion a day in trading through September.
Four provisions do that work: the funds and accounts, the permitted investments list, how the investments are valued and the trustee's duties, and the wider framework for investing bond proceeds goes beyond any one document.
Which funds and accounts does an indenture establish?
An indenture establishes separate funds and accounts for the different jobs the money has to do.
SEC Rule 15Ba1-1(m), the proceeds definition in the municipal advisor rules, counts sale proceeds, investment income and pledged funds such as reserves and sinking funds held under the bond documents as proceeds, and it says the money ceases to be proceeds when it is spent to carry out the authorized purposes of the securities.
That definition comes from the SEC's municipal advisor rules and is not the tax definition of proceeds in the arbitrage regulations.
The MSRB glossary places its debt service fund entry under a flow of funds heading.
| Fund or account | What it holds under the bond documents |
|---|---|
| Construction or project fund | Sale proceeds awaiting expenditure on the project's authorized purposes |
| Debt service fund | Periodic deposits made so debt service is paid on time, often in a separate principal account and a separate interest account |
| Reserve and sinking funds | Pledged funds held under the bond documents |
The MSRB glossary's debt service fund entry describes a fund the issuer makes periodic deposits into so that debt service is paid on time, and it notes that the fund may contain a separate principal account and a separate interest account in which funds for those respective purposes are held.
Sub-accounts matter because a single fund can hold money for more than one purpose, and the glossary notes that the debt service fund may hold funds for the respective purposes in separate principal and interest accounts.
How the debt service fund is invested, and how the arbitrage rules treat it, is its own subject.
The construction fund's money in that example would be spent on the project's authorized purposes, while the reserve fund's would sit against the possibility that pledged revenues fall short, the job the MSRB glossary gives a debt service reserve fund, so the two would not carry the same liquidity terms.
The bond funds guide takes each fund in turn, including the capitalized interest, cost of issuance and rebate funds the table does not break out.
What does the permitted investments clause do?
The permitted investments clause is the part of the bond contract that sets the instruments in which bond proceeds or other funds may be invested, which is how the MSRB glossary defines permitted investments.
| Term the contract uses | MSRB glossary meaning |
|---|---|
| Permitted investments | The instruments in which bond proceeds or other funds may be invested pursuant to the provisions of the bond contract |
| Eligible securities | A term that often refers specifically to the securities the bond contract allows in a defeasance escrow |
The MSRB glossary says eligible securities often refers specifically to the securities the bond contract allows in a defeasance escrow.
How an escrow is built around that list is covered in the refunding escrow guide.
What the instruments themselves look like in practice is the subject of the investment products guide, and where the clause sits among state statute and the issuer's policy is taken up in the permitted investments guide.
GFOA's best practice ties the bond-proceeds provisions of an investment policy to process as well as to a list: it recommends that legal and regulatory requirements are met, that fair market value bids are received when required by tax law and state or local laws, and that issuer objectives are attained.
The federal tax rule behind that bid requirement is covered in the fair market value safe harbor guide.
How are fund investments valued?
For federal yield-restriction purposes, Treasury Regulation §1.148-5(d)(2) generally requires yield-restricted nonpurpose investments to be valued at present value.
That tax rule is a separate question from how an indenture's own terms handle valuation, which is covered in the valuation provisions guide.
What duties does the trustee have under the indenture?
The trustee is a financial institution with trust powers that acts in a fiduciary capacity for the benefit of the bondholders under the bond contract, as the MSRB glossary describes, and it often also serves as custodian, paying agent, registrar or transfer agent.
For the investments, the custodian role is where the contract's investment terms land: where the trustee is also custodian, it holds the investments the funds are put into, as a fiduciary for the bondholders.
When the institution serving as trustee is also asked for advice on those investments, the SEC's municipal advisor rule applies, and it exempts banks advising on deposits, extensions of credit or sweep accounts under 15Ba1-1(d)(3)(iii).
The exemption for investments made as indenture trustee, at 15Ba1-1(d)(3)(iii)(D), is narrow.
The same rule exempts accountants doing audit or attest work and public officials and employees acting in their official capacity.
It also exempts responses to a request for proposals or qualifications, so long as the responder does not receive separate direct or indirect compensation for advice provided as part of the response.
A provider that fits none of those exemptions can still give advice without registering as a municipal advisor when an independent registered municipal advisor is advising the issuer on the same aspects of the transaction, the issuer gives a written representation that it relies on that advisor, and the required written disclosures are made, under 15Ba1-1(d)(3)(vi).
Where the trustee sits among the other members of a financing is covered in the financing team guide.
Reading the investment provisions is one job and pricing investments that fit them is another, and that second job is mGIC's: it is an independent, SEC-registered municipal advisor and Bidding Agent, and it reports 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.
Its representative reinvestment transactions span transportation, public power, aviation, higher education and water, including Pocahontas Parkway in Virginia and the Grand River Dam Authority in Oklahoma.
To have an indenture's investment provisions read against a fund's objectives and draw schedule, contact mGIC for a free, no-obligation reinvestment review.
Final determinations about what an indenture permits for a particular issue belong to bond counsel and tax counsel.
Frequently asked questions
What is the difference between permitted investments and eligible securities?
The MSRB glossary defines permitted investments as the instruments in which bond proceeds or other funds may be invested under the bond contract. Eligible securities is a related term that often refers specifically to the securities the bond contract allows in a defeasance escrow.
Can a bank advise on investments made as indenture trustee without registering as a municipal advisor?
Within limits, yes. SEC Rule 15Ba1-1(d)(3)(iii) exempts banks advising on deposits, extensions of credit, sweep accounts or investments made as indenture trustee, and the exemption for indenture trustee investments is narrow. Whether a specific arrangement fits is a legal question.
Who are the parties to an indenture?
The MSRB glossary describes an indenture as a contract between the issuer of municipal securities and a trustee, for the benefit of the bondholders. It sets out the parties' rights, duties and remedies and the exact nature of the security for the bonds.
Who benefits from the trustee's fiduciary duty?
The bondholders. The MSRB glossary describes the trustee as a financial institution with trust powers, designated by the issuer or borrower, that acts in a fiduciary capacity for the benefit of the bondholders and often also serves as custodian, paying agent, registrar or transfer agent.
Sources
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.
