Executive Summary
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Sukuk issuance utilizes a number of different shariah structures but all make use of the purchase undertaking.
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The purchase undertaking is the key credit document in sukuk issuance. It provides for the return on an investment at maturity and under any early redemption right, whether arising as the result of a default event or otherwise.
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Purchase undertakings have come under great scrutiny from shariah scholars, who feel that they have been developing into an instrument guaranteeing a return on certain types of sukuk that should be subject to the investment risk associated with an equity investment.
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AAOIFI has sought to move sukuk away from classification as a pure debt instrument toward reclassification as an equity instrument, in order to better reflect the position of sukuk in the Islamic finance sphere.
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An evolution in market perception will need to occur to move transaction risk disclosure, and therefore investor focus, away from focusing solely on the obligor under the purchase undertaking toward greater focus on the creditworthiness of the sukuk assets as well.
Introduction
As is the case with most Islamic finance instruments, the typical approach to sukuk is to take the equivalent instrument in conventional finance and to attempt to replicate it in a way that is shariah-compliant. In the case of sukuk, consideration is given to the important commercial features (such as rate of periodic return, return at maturity, and financial covenants), together with key legal considerations (such as transaction risk disclosure, events of default, and representations and warranties). The market has tended to place sukuk in the same asset class as a conventional bond and has thus identified sukuk as debt capital market instruments. However, this view is at odds with Islamic jurisprudence, which, though differing on certain issues of interpretation in relation to detail, has almost universally agreed that sukuk should be viewed as equity investments, thereby exposing the investor to ownership risk in relation to the assets they have purchased through their investment in sukuk. This issue came to a head in February 2008, with the announcement by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)1 that in its view the majority of sukuk in the market at that time were not in compliance with the precepts of shariah. The concerns of the scholars centered around the use and application of the purchase undertaking in sukuk transactions, and particularly the methodology used to determine the exercise price (or purchase price) for the sukuk assets upon an exercise by the issuer/trustee of its right to require the obligor to purchase those sukuk assets pursuant to the terms of the purchase undertaking.
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