Purchase Undertaking
A purchase undertaking is a unilateral promise, usually by the originator of a sukuk, to buy back the underlying assets from the issuing vehicle at maturity or on default, at a price that typically repays investors' principal and any unpaid profit.
Also called: purchase undertaking deed · wa'd to purchase · sukuk purchase undertaking · exercise price undertaking
Most sukuk are structured so that investors are repaid by the originator, not by selling the assets in the market. In an ijara sukuk, for example, the originator sells an asset to a special purpose vehicle, leases it back and pays rent that funds the periodic distributions. At maturity, or if the originator defaults, it is bound by a purchase undertaking to buy the asset back. The exercise price is set to equal the face value of the certificates plus any unpaid amounts, which is why sukuk pay like debt.
In Islamic law the undertaking is a wa'd, a binding promise by one party, rather than a two-way contract of sale. Scholars have long debated how far it may guarantee principal. In February 2008 the AAOIFI Shari'a board objected to managers or partners in partnership-type sukuk, such as mudaraba, musharaka and wakala structures, promising to repurchase assets at face value, since that shifts the investors' ownership risk back to the manager. Lease-based structures are treated differently in practice.
The undertaking is usually governed by English law, and its enforceability was tested in the Dana Gas litigation of 2017. Dana Gas argued that its mudaraba sukuk had become unlawful under UAE law and should not be enforced. In November 2017 the English High Court held that the English-law purchase undertaking was valid and enforceable. The case confirmed that, in an asset-based sukuk, investors' real protection is the originator's English-law promise.
In practice
A purchase undertaking is only as strong as the originator's credit. It is the reason most sukuk are rated on the issuer's credit rather than on the underlying assets.
Example
A company issues US$500 million of ijara sukuk. On default, the trustee calls the purchase undertaking and the company must pay an exercise price of US$500 million plus accrued rental, whatever the leased building would fetch on the open market.
Learn more on Money Wiki
This page gives the short answer. Money Wiki has a longer guide to Purchase Undertaking, with more detail and background.
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See also
- Asset-Backed SukukAsset-backed sukuk are sukuk whose underlying assets are transferred to the issuing vehicle in a true sale, so investors own and can look to those assets for repayment, rather than relying only on the originator's promise to pay.
- SukukSukuk are certificates representing undivided ownership interests in assets, usufructs, services or ventures, with returns paid from what those underlying interests generate. "Islamic bond" is useful shorthand but not an accurate legal description.
- IjarahIjarah is an Islamic lease: the owner of an asset transfers the right to use it for an agreed period in return for rent, while keeping ownership and the risks that come with ownership.
- Special Purpose VehicleA special purpose vehicle is a legal entity created for one narrow purpose, such as holding a set of assets or issuing securities, and kept separate from its sponsor so that its assets and liabilities are ring-fenced from the sponsor's.
- AAOIFIAAOIFI, the Accounting and Auditing Organization for Islamic Financial Institutions, is a Bahrain-based international standard-setter whose Sharia, accounting, auditing, governance and ethics standards are widely used in Islamic finance.
- True SaleA true sale is a transfer of assets that is effective in law as an outright sale, so the assets leave the seller's estate and cannot be claimed by the seller's creditors if it becomes insolvent. It is the foundation of securitisation.