Certificate of Participation (COP): Definition, Uses, Taxation

What Is a Certificate of Participation (COP)?

A certificate of participation (COP) is a type of financing where an investor purchases a share of the lease revenues of a program rather than the bond being secured by those revenues. Certificates of participation are, therefore, secured by lease revenues.

A certificate of participation (COP) can also be referred to as a participation certificate.

Key Takeaways

  • A certificate of participation (COP) allows investors to participate in a pro-rata share of a lease-financing agreement.
  • A lease-financing agreement is used by a municipality or local government to acquire real property.
  • As opposed to bond participation, COPs pay investors via lease revenues as opposed to bond interest.
  • COPs are commonly found in municipal financing as an alternative to muni bonds.
  • A certificate of participation is also a tax-exempt lease-financing agreement.

Understanding a Certificate of Participation (COP)

A lease-financing agreement is used by a municipality or local government to acquire real property. Under the agreement, the local government makes regular payments over the annually renewable contract for the acquisition and use of the property. A lease-financing contract is typically made available in the form of a certificate of participation.

A municipal government will typically issue muni bonds from which the proceeds from the bond investors will be used to undergo a project. The certificate of participation is an alternative to municipal bonds in which an investor buys a share in the improvements or infrastructure the government entity intends to fund.

The authority usually uses the proceeds from a COP to construct a facility that is leased to the municipality, releasing the municipality from restrictions on the amount of debt that they can incur. The COP contrasts with a bond, in which the investor loans the government or municipality money in order to make these improvements.

COPs and Taxation

A certificate of participation is a tax-exempt lease-financing agreement that is sold to investors as securities resembling bonds. In a COP program, a trustee is typically appointed to issue the securities that represent a percentage interest in the right to receive payments from the local government under the lease-purchase contract.

Investors that participate in the program are given a certificate that entitles each investor to a share, or participation, in the revenue generated from the lease-purchase of the property or equipment to which the COP is tied. The lease and lease payments are passed through the lessor to the trustee, who oversees the distribution of the payment to the certificate holders on a pro-rata basis.

Special Considerations

Certificates of participation do not require voter approval and also can be issued more quickly than referendum bonds. In addition, COP financing is more complex and generally resembles bond financing. An underwriter of the COPs will be required, as will various fiscal agents.

An official statement providing disclosure to investors must be approved by the municipal government and, in most cases, the government must contract to make continuing disclosures to SEC Rule 15c2-12 under the Securities Exchange Act of 1934.

COPs are also used as credit instruments by banks to raise funds from other banks in order to ease liquidity. Short-term funds are raised by issuing participation certificates that involve sharing credit assets with other banks. The rate at which these certificates can be issued will be negotiable depending on the interest rate scenario.

What Is COP Debt?

COP debt is a certificate of participation debt. This type of debt is issued by state authorities and secured by revenues from leases; either equipment or property/facility. This allows state authorities or local municipalities to raise financing for projects within the jurisdiction without having to issue bonds/long-term debt.

Why Would Someone Buy a Bond Over a Stock?

Investors that choose bonds over stocks are looking for a guaranteed and predictable income stream, which bonds pay out at regular intervals. In addition, if bonds are held to maturity, then an investor receives back the full principal amount. Bonds are a way to receive income while preserving the initial investment.

What Are the Advantages of Municipal Bonds?

Municipal bonds are tax-exempt, they are used for positive ends, such as building infrastructure within a locality, they are fairly low risk with a low default rate, and they are also fairly liquid investments.