Islamic bond problems herald due-diligence era

By Cecilia Valente and Frederik Richter

LONDON/MANAMA (Reuters) - Islamic bond defaults and the standstill requested for Dubai's Nakheel will transform the market as investors demand more transparency and subject new issues to forensic due diligence.

Investors in real estate developer Nakheel were stunned following the announcement on Wednesday that the company and its owner state-run Dubai World would delay by at least six months repayment on billions of dollars in debt.

Nakheel had a $3.5 billion (2.1 billion pound) Islamic bond, the largest ever issued, maturing on December 14, an obligation the market widely expected to be honoured.

"If there are lessons to be learned here, it is that due diligence is all important. Compliance to sharia in its structuring does not ensure the success of a sukuk or of any product or business," said Yusuf Talal DeLorenzo, chief sharia officer at fund management company Shariah Capital.

The sukuk market was already jittery before the news from Dubai. Earlier this month prominent Saudi business group Saad said it would miss the payment of the second bi-annual coupon on its $650 million Golden Belt Sukuk Belt 1 Sukuk domiciled in Bahrain..

In May Kuwait's Investment Dar (TIDK.KW) said it defaulted on a $100 million sukuk.

In its simplest form sukuk are certificates proving ownership of an asset but unlike bond holders, sukuk investors do not receive interest but rather returns generated by the underlying assets pooled under special purpose vehicles (SPV).

The events have shaken the reputation of sukuk as safer and more transparent than their conventional counterparts -- just as the market was recovering from a slump in 2008, with issuance up 40 percent in the first ten months of the year.