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municipalauthorities.org | 31 PlGIT’ s I nvesTmenT a DvIser ’ s recommenDaTIons for local GovernmenT InvesTInG for a chanGInG economIc clImaTe By Paul Robinson, Institutional Sales & Relationship Manager, PFM Asset Management, a division of U.S. Bancorp Asset Management, Inc. In our last column in The Authority, we continued our review of the Four Pillars of Local Government Investing. Specifically, we looked at long-term investments. In this final “installment,” we will be reviewing Pillar #4, the investment of bond proceeds. The process of managing the proceeds of a tax-exempt bond issue is different from other municipal funds. Local governments spend months planning, coordinating and issuing bonds. But they should take equal care to implement a strategy for the investment of the proceeds, focusing on a few basic points: Keep an eye on the big picture The Government Finance Officers Association (GFOA) recommends several broad rules that local governments can follow to maintain regular oversight on their reporting responsibilities. (Source: gfoa.org. Developing and Implementing Procedures for Post-Issuance Tax Compliance for Issuers of Governmental Bonds ) To be effective, local governments should have clear procedures in place to address the substantive issues necessary to assure tax and other legal compliance as they relate to tax-exempt bonds. According to the GFOA, these procedures should include: • A designated individual or individuals for coordinating activities • A due diligence review at regular intervals • Training for responsible individuals • The retention of adequate records • An identification of areas that are most susceptible to noncompliance • Procedures to correct identified noncompliance in a timely manner Understand arbitrage Because of its importance -- and potential consequence for mishandling -- most issuers of tax-exempt bonds know something about arbitrage and arbitrage rebate . Even so, here is a short refresher: when a local government issues a bond for a building project or another purpose, it invests the proceeds so it can earn interest until the funds are used. “Arbitrage” refers to the difference between the arbitrage yield – the interest rate at which bonds are issued – and the investment yield , the interest rate at which bond proceeds are invested. If the investment yield exceeds the arbitrage yield, the dollar difference in earnings is “positive arbitrage.” That positive arbitrage must be rebated to the IRS unless certain exceptions are met. Conversely, if the investment yield is less than the arbitrage yield, the dollar difference in earnings is “negative arbitrage” and no rebate is owed. Monitor arbitrage rebate As straight-forward as that description of arbitrage might sound, the rules that govern the process are highly complex – and can be confusing to many issuers. In managing arbitrage, issuers must adhere to a complicated Continued on page 43.