By Andrew Newby

DUBAI, Dec 02, 2009 (AFp) - Dubai World's plan to delay repaying a huge Islamic bond issue may damage the image of sharia finance, not due to inherent problems but rather because investors have ignored key questions, analysts say.

"In many ways, this has been an extraordinary crisis, but it is the first for the empyonic sukuk industry," said Khalid Howladar of Moody's Investors Service.

Another expert, professor Habib Ahmed of Durham University, said the crisis points to the need for a better understanding of the rules applying to sukuk.

"This case is a wake-up call for Islamic finance to focus more on ethical and moral issues that it has been ignoring for so long," Ahmed told AFp.

A widespread view among economists is that fears about the rights of the Dubai World bondholders relate at least as much to a lack of clarity in the Dubai legal system as they do to the rules of Islamic finance.

In addition, much of Dubai's spending has gone on speculative construction projects and the 50 percent fall in property prices in the emirate means all real estate-related finance deals face a problem whether using Islamic or Western rules, they say.

Islamic sharia rules forbid usury, so anyone lending money is barred from charging interest. Instead, investors are granted a share of the assets and in the case of a property developer, the issuer of a sukuk will typically pay a rent until refunding the loan when it matures.

Dubai World's property unit Nakheel, developer of Dubai's iconic palm Jumeirah artificial island resort, is scheduled to repay a 3.5 billion dollars sukuk on December 14, so it is the first subsidiary affected by the group's request last week for a six-months halt to debt repayments.

"The maturity date of the sukuk was December 14, 2009 when Nakheel was supposed to pay the last rental coupon and buy back the assets, but instead declared its inability to perform," said Ahmed, chair in Islamic law and finance at Durham's Institute of Middle Eastern and Islamic Studies.

Theoretically at least, Islamic laws on financial transactions have some inherent features that induce stability, he said.

"The ban on interest and other rules would prevent Islamic investors investing in certain instruments such as conventional bonds and derivatives," which caused last year's global credit crunch, Ahmed said.

"Until now, Islamic economists have been saying that Islamic finance was not affected directly by the subprime problems. The Nakheel problem shows that Islamic finance can have similar problems if wrong investments are made," he said.

One reason for this is that many sukuk are structured to resemble conventional bonds, meaning the risks of ownership are transferred to the issuer rather than shared by the investors, the professor said.

"This is one of the criticisms of Islamic products: instead of coming up with products that reflect the spirit and substance of Islamic law, they are structured very similar to conventional products," Ahmed said.

A source who asked to remain anonymous because his company has extensive dealings in the region said credit ratings agencies have valued Islamic debt on the creditworthiness of the issuer rather than the assets because of doubts over investors' claim to the assets.

"Noone has confidence in sukuk investors to foreclose on the assets" they have lent money on in Dubai and several countries using sharia rules, because the legal system in those countries is "underdeveloped," he said.

The Dubai International Financial Centre, a business district which opened in 2004 with the aim of making the emirate a world-class financial hub, uses English law within its perimeter because of the lack of precision in sharia law, the source told AFp.

Moody's Howladar agreed with Ahmed that many sukuks are too similar to convention finance for their own good.

"The desire for Middle Eastern corporate credit exposure and unsecured debt has created sukuk instruments that, in substance, attempt to be identical to conventional bonds," he said in a study released this week.

Restructurings such as Dubai World's are common in mature markets, but the "immature and opaque nature" of Dubai's law system and the lack of precedent "give little comfort to investors spread across the world," he said.

"Given the sheer scale and complexity of Dubai World, this event will be an important test of investorsââ‚