ANALYSIS - Sukuk: safe Islamic investments or risky business?

By Liau Y-Sing

KUALA LUMPUR (Reuters) - For years, sukuk have been structured and sold as Islamic bonds, but a high-profile default is renewing debate about whether they are in fact equity-like instruments that expose investors to greater risk.

As the sukuk market emerges from the shadow of the global credit slump, the $1 trillion industry is grappling with the extent to which sukuk should mirror conventional bonds, an issue which will determine holders' returns and whether they will be first to be repaid if the investments sour.

How investors view sukuk could influence demand for the best-known sharia financing tool and the pace at which Islamic finance and $107 billion sukuk market will grow.

Sukuk are strictly ownership certificates, but in practice they have become known as Islamic bonds with their investors holding debt.

The question of a sukuk holders' rights has come under scrutiny after an issuer, U.S. energy firm East Cameron, filed for bankruptcy in October 2008.

The case, which is still proceeding in a U.S. bankruptcy court, could shed light on the extent to which East Cameron's sukuk holders own the oil revenues that underpinned the sukuk issue and indicate how sukuk should be structured so that holders get paid in the event of bankruptcy.

The East Cameron sukuk holders are considering a plan of reorganisation which has yet to be filed with the bankruptcy court, said Michael McMillen, a partner with the East Cameron sukuk holders' lawyers Fulbright & Jaworski.

"Alternatives being considered for the reorganisation plan include collapsing the current structure in such a manner that the sukuk holders will become equity holders in the debtor entity," McMillen said.