How Is a Refunding Escrow Structured and Funded?

A refunding escrow is a fund, or a set of funds, that holds a refunding issue's proceeds and other amounts so they can pay principal and interest on the bonds being refunded, and it is funded with SLGS bought directly from Treasury or with securities bought in the open market, generally Treasuries and agencies.

What does an escrow do in a refunding?

The escrow is the fund that stands behind the refunded bonds, and its job is to provide their principal and interest payments.

Treasury Regulation §1.148-1(b) defines a refunding escrow, for arbitrage purposes, as one or more funds established as part of a single transaction or a series of related transactions, containing proceeds of a refunding issue and any other amounts to provide for payment of principal or interest on one or more prior issues.

The escrow deposit agreement governs: the MSRB glossary describes it as setting forth the manner in which funds are to be invested pending their expenditure and the schedule on which ongoing debt service payments are to be made.

In that agreement, "eligible securities" often refers specifically to the securities the bond contract allows in a defeasance escrow.

Bonds are escrowed to maturity when the escrow pays them on their original schedule, and they are prerefunded when the escrow runs only to a call date or dates, with the refunded issue redeemed at that time, in the MSRB glossary's terms.

In a crossover refunding, the MSRB describes the original revenue stream as continuing to pay the refunded bonds until they mature or are called, then crossing over to the refunding bonds, while refunding bond debt service is paid from interest earnings on the invested proceeds.

How long the escrow must run starts with the current-versus-advance distinction: for federal tax purposes a current refunding issue is issued not more than 90 days before the last expenditure of its proceeds to pay the prior issue, and any other refunding is an advance refunding (26 CFR 1.150-1(d)(3)-(4)).

The MSRB notes that refundings of less than 90 days may still count as advance refundings under state law or bond contracts, so the label depends on which definition governs.

Interest on a bond issued to advance refund another bond is not exempt from federal income tax under Internal Revenue Code §149(d)(1), added by Pub. L. 115-97 §13532 for advance refunding bonds issued after December 31, 2017.

Tax-exempt current refundings and taxable advance refundings remain available under that rule, and which structure fits a given issue is a determination for bond counsel and tax counsel.

The refunding types and their labels are covered in What are the types of bond refundings.

The effect on the refunded bonds' covenants is covered in What does it mean to defease municipal bonds.

How is the escrow funded: SLGS or open-market securities?

The MSRB glossary says advance refunding proceeds are generally invested in Treasury securities or federal agency securities, although other instruments are sometimes used.

The other main route is the State and Local Government Series, and the MSRB notes that SLGS are most commonly used for deposit in an escrow account in connection with the issuance of refunding bonds.

Treasury sells SLGS as non-marketable securities to give issuers of tax-advantaged bonds, which for SLGS purposes includes conduit borrowers, investments bought with an eligible source of funds (31 CFR 344.0(a), 344.1).

An eligible source of funds mainly means gross proceeds of tax-advantaged bonds, and the 31 CFR 344.1 categories include amounts held with gross proceeds in a refunding escrow, defeasance escrow, parity reserve fund or commingled fund.

Whether a particular fund qualifies as an eligible source is a question for bond counsel.

SLGS come as Time Deposits, issued as certificates of indebtedness, notes or bonds, or as Demand Deposits, issued as certificates of indebtedness (31 CFR 344.0(b)).

The issuer fixes each maturity within Treasury's ranges: 15 days to one year for non-interest-bearing certificates, 30 days to one year for interest-bearing certificates, one year and one day to 10 years for notes, and 10 years and one day to 40 years for bonds (31 CFR 344.4(a)).

The maximum rate is the SLGS rate, the current Treasury borrowing rate less one basis point and floored at zero if that result would be negative, with Treasury itself determining the borrowing rate (31 CFR 344.1).

Treasury releases the daily SLGS rate table by 10 AM Eastern each business day, the table in effect on the business day the subscription process starts is the one that applies, and the subscriber may designate any rate up to the maximum (31 CFR 344.4(b)).

Lead times are fixed by rule: Treasury must receive the subscription at least 5 calendar days before the issue date for $10 million or less and at least 7 calendar days for more than $10 million, and the issue date must be a business day no more than 60 days after Treasury receives the subscription (31 CFR 344.5(a)).

SLGS cannot be sold, exchanged, assigned or pledged, and Treasury cannot call them before maturity (31 CFR 344.2(d), (o)).

Using the program to create a cost-free option, a provision used to exploit interest-rate movements, is an impermissible transaction under 31 CFR 344.2(f), which Treasury can answer by revoking issuance and declaring the subscriber ineligible (31 CFR 344.2(m)(4)).

Subscribers certify the securities' yield, certify that the term is no longer than reasonably necessary for the governmental purpose, and must tell Treasury if eligibility ends (31 CFR 344.2(e)).

The subscription, cancellation and settlement mechanics are covered in What are SLGS.

The open-market route buys securities in the market rather than subscribing for them from Treasury.

STRIPS separate a fixed-principal Treasury note, bond or TIPS into zero-coupon pieces that each pay once at maturity, with bills and floating rate notes unable to be stripped and stripping and reassembly handled only in the commercial book-entry system (31 CFR 356.31; TreasuryDirect).

Because each strip pays once at a fixed date, pieces can be matched to individual refunded payments without carrying unneeded coupon dates.

Open-market pricing is also where the yield-burning problem sits: the MSRB glossary defines yield burning as the sale to an issuer of securities, typically Treasury securities, at above-market prices to be held in escrow to reduce the yield on those securities and avoid arbitrage regulations, and it notes the SEC and IRS view the practice as illegal.

That practice is covered in What is yield burning in municipal escrows.

State statutes can narrow the menu of escrow securities further.

Michigan's Revised Municipal Finance Act lets refunding proceeds deposited in trust buy direct U.S. obligations, noncallable and nonprepayable obligations unconditionally guaranteed by the United States as to full and timely payment of principal and interest, Treasury-program strips, and Resolution Funding Corporation bonds and strips, sized to pay the refunded securities (MCL 141.2607(2)).

The Michigan list does not name SLGS separately, even though SLGS are obligations of the U.S. Treasury.

Washington's Refunding Bond Act provides that refunding bond proceeds, plus other funds set aside to pay the refunded bonds, may be invested and reinvested only in government obligations maturing in time to pay the refunded bonds under the refunding plan, a defined term covering U.S. direct or unconditionally guaranteed obligations and bank certificates of deposit secured by them, obligations of the banks for cooperatives, the federal intermediate credit bank, the FHLB system, the Export-Import Bank, the federal land banks and FNMA, public housing bonds and project notes secured by U.S. contracts, and insured institution obligations to the extent insured (RCW 39.53.060, 39.53.010(4)).

The state-by-state detail is in the Michigan and Washington state pages.

The choice between SLGS vs open-market securities for a particular escrow is compared in detail there.

What does the escrow verification report show?

A verification report is an independent check that the escrow's securities will produce enough money on the dates the refunded bonds come due.

GFOA describes the verification agent, typically a CPA firm, as confirming that the escrow is sufficient and, where the escrow's yield is limited, that the escrow yield does not exceed the permitted yield.

The yield leg matters because the standard is tight: for investments in a refunding escrow, Treasury Regulation §1.148-2(d)(2)(ii) treats materially higher as one-thousandth of 1 percentage point.

Custody is separate: GFOA describes the escrow agent, typically a commercial bank, as the party that holds the escrow's investments.

How these roles fit together is covered in Who is on a municipal bond financing team.

The full checklist a verification agent runs is covered in What does an escrow verification agent check.

Whether a particular escrow meets the federal yield limit is a legal determination for bond counsel and tax counsel.

How are open-market escrow securities competitively bid?

Open-market escrow securities can be competitively bid rather than subscribed for from Treasury, and GFOA notes that funding an escrow with open-market securities may require an escrow bidding agent that solicits bids for securities used in the escrow.

GFOA adds that a municipal advisor, if the issuer has engaged one, may be able to act as the escrow bidding agent.

mGIC serves as an independent, SEC-registered municipal advisor and Bidding Agent for escrow and other bond-proceeds investments, preparing bid specifications, soliciting qualified providers, managing questions during the solicitation, and receiving and comparing bids on rate and non-rate terms.

The engagement ends with documentation and settlement, where mGIC coordinates with the provider's counsel and financing team and delivers Bidding Agent and provider certifications to bond counsel with a compliance file.

mGIC sells no proprietary investment product and does not act as principal, and its fee is paid by the winning provider rather than the issuer, at or below the safe-harbor maximum in the Treasury arbitrage regulations and disclosed under those regulations.

How those fees are set is covered in How are bidding agent fees set and who pays them.

Its Bidding Agent and reinvestment advisory work since 2002 includes more than $60 billion in bond proceeds invested and swap notional executed across more than 1,000 transactions in more than 40 states.

Because an escrow's securities are built to the schedule in the escrow deposit agreement, the bid comparison runs across rate and non-rate terms, not just a headline yield.

Issuers planning a refunding can ask mGIC to bid your escrow as part of a free, no-obligation review of the structure.

What happens when a refunding escrow has to be restructured?

A restructuring re-matches the escrow's securities to a changed payment schedule or deal structure, and for SLGS the room to do that is set by Treasury's subscription and redemption rules.

While a SLGS Time Deposit subscription is still open it can be changed until 3 PM Eastern on the issue date, but each security's principal cannot move by more than 10 percent and maturities cannot move more than 30 days for certificates, 6 months for notes or 1 year for bonds (31 CFR 344.5(d)-(f)).

The SLGS issue date cannot change except up to 7 days later for unforeseen circumstances beyond the issuer's control (31 CFR 344.5(d)).

Once issued, SLGS are fixed: they cannot be sold, exchanged, assigned or pledged, so a change means redeeming securities early rather than replacing them (31 CFR 344.2(d)).

Early redemption has its own clock: a note or bond cannot be redeemed sooner than 30 days after issue, a certificate of 30 days or more no sooner than 25 days, and Treasury must receive the redemption request 14 to 60 days before the redemption date (31 CFR 344.6).

Cancelling a subscription outright requires establishing, to Treasury's satisfaction, that the cancellation is required for reasons unrelated to creating a cost-free option (31 CFR 344.5(c)).

GFOA's refunding policy guidance addresses negative arbitrage: it suggests governments may want a guideline that negative arbitrage in an advance refunding escrow stays below a set percentage of net present value savings, alongside a refunding-efficiency test based on the value of the call option.

Those are GFOA's sample policy ideas rather than requirements.

How negative arbitrage arises and is measured is covered in What is negative arbitrage.

If a restructured escrow runs only to a call date rather than to the refunded bonds' maturities, the MSRB's term for the bonds shifts from escrowed to maturity to prerefunded.

For a no-obligation conversation about funding, verifying or restructuring a particular escrow, contact mGIC.

Last updated 2026-10-06.

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.