The sukuk market may well be set to bounce back after suffering badly in the global financial downturn.

The value of sukuk has jumped 61 per cent in the past year, according to a research by Trowers & Hamlins, the international law firm.

A total of $7 billion of sukuk were issued in the year to June 2010 compared to $4.3 billion the previous year.

At the same time issuance of conventional bonds surged to record levels. The value of conventional bonds issued in the Gulf hit $15 billion to $12.9 billion the year before, an increase of 16.3 per cent.

Trowers & Hamlins says that the sukuk market was hit much harder by the credit crunch and global financial crisis than the conventional bond market in the Gulf.

In addition to the wider negative effect on global financial markets flowing from the credit crisis, the reputation of sukuk and sentiment to sukuk as potentially safer investment instrument than corporate bonds took a battering after investors were left nursing potentially heavy losses following several high-profile sukuk defaults like Golden Belt, Investment Dar and International Investment Group. These defaults hit demand for sukuk as investors realised that, contrary to popular belief, many sukuk were neither genuinely asset-backed nor came with an express or implicit sovereign guarantee.

Trowers & Hamlins says that, as well as facing these broader structural issues, many sukuk were primarily based on land values or revenues intended to flow from real estate and construction projects, an asset class and sector that lost much of its allure during the downturn, with Dubai particularly hard hit.

'While sukuk issuance has rebounded, it is still less than half of its peak in 2007-08,' said Trowers & Hamlins Bahrain regional banking and finance partner Neale Downes.

'The financial crisis was the first real test for sukuk. Investors are flocking to the comparative safety of conventional bonds while issuers address some of the particular legal and structural concerns surrounding sukuk and their robustness in a default or insolvency scenario,' he added.

'The crisis laid bare several misunderstandings about sukuk.

'Many investors assumed that sukuk came with a sovereign guarantee, or that if the issuer defaulted they would have an underlying asset as security or that they had sole recourse to such asset. The limitations of merely asset-based sukuk are now more widely understood,' he said.

'With restricted access to liquidity from banks, borrowers have been forced to access other sources of debt or capital.

'But with the cost of issuing sukuk now about 60 per cent more expensive than bonds, corporates have largely turned to conventional debt,' he said.

'The market reached its nadir in 2009 but sentiment towards sukuk now appears to be recovering strongly.

'There is every reason to believe that demand for sukuk will eclipse its pre-credit crunch peak in the coming years,' he added.-TradeArabia News Service