In an exclusive report from the 2008 Sukuk Summit in London, Richard Agnew profiles the UK's capital's bid to become the Islamic finance capital of Europe.

The City of London has had a rough time recently, with markets being hit by the credit crunch and growing pessimism over the economy. But for the city's Islamic financiers, the outlook looks rosier.

At last month's Sukuk Summit in London, which focused on the nascent Islamic bond industry, headhunting firms were out in force and were offering top dollar to those with the right skills.

"A few people raised their eyebrows when I said I was studying Islamic finance," said one delegate. "But I definitely don't have any regrets."

With confidence high, it's not a surprise that the sector is keen to see movement on the UK government's planned launch of a multi-billion dollar Sukuk programme - an idea it has been considering since early last year, but is yet to move decisively on.

Sukuk - bonds that are structured to circumvent Sharia restrictions on the charging or payment of interest - have seen rapid uptake in recent years as more and more businesses and governments have used them to raise financing.

Much of this activity has taken place in the Gulf and South East Asia so far, and analysts believe a government issue could be the fillip the UK needs to cement its place as an Islamic finance centre in Europe.

Mindful of the benefits that would bring to financiers, frustration at the government's reluctance to make a concrete commitment was evident at the Summit.

In his speech, Darko Hajdukovic, international product manager at the London Stock Exchange (LSE), "strongly encouraged" the UK Treasury to press ahead with the issuance. He urged officials "not to lose track of time" while making their deliberations.

And speaking on the sidelines, one senior executive from a Middle East bank went further, accusing the government of "grandstanding" when it announced its intention to look into the idea in early 2007.

Michael Ainley, head of the Financial Services Authority's International Firm Department, which regulates the Islamic banking market in the UK, was forced to defend the perceived hold-up, saying it was necessary to work through all the legal ramifications before making a final decision.

"There has been a lengthy process of consultation, and I know there is some feeling that things should be moving faster," he said.

"However, it took us a couple of years of good natured and intense negotiations to get there when we were licensing our first Islamic bank. We do not want to get this wrong. Personally, I am very happy it is taking this length of time."

For the UK government and wider Sukuk industry, much is at stake. The market for Islamic bonds has not been immune to global economic difficulties in recent months, having reportedly experienced a slowdown in new issues this year.

But ratings agency Moody's predicts that it will expand by about 35% a year to be worth US$200bn by 2010, helped by new sales in countries like the UK.

Although the UK has already attracted several Sukuk issuances (the Central Bank of Bahrain launched its sovereign Sukuk in London in March, taking the total number of such bonds on the LSE to 18), analysts say a large show of support by the government would help it attract a bigger slice of this new business.

Observers also put forward further reasons for quick action. Governments, they point out, often support the development of new capital markets, such as Sukuk, by being the first to participate in them. By doing so, their issues provide secure assets that the private sector can turn to when structuring their own investments.

A sovereign issue could also potentially galvanise secondary trading in Islamic bonds and help create a wider range of financial services for the UK's estimated 1.4 million Muslim adults.

Theoretically, Sukuk have even been mooted as a fund-raising tool for infrastructure projects like the London Olympics in 2012 (although the Treasury denies that this has been considered).

Professor Rifaat Abdel Karim, secretary general of the Islamic Financial Services Board (IFSB), which sets worldwide Islamic banking standards, says "high-grade" sovereign issuances by the likes of the UK would create wider international acceptance of Islamic bonds: "These issues would provide institutions that offer Islamic financial services with good quality assets, which are critical for their investment and liquidity management operations.

"Such issuances will also assist in providing sufficient market breadth and depth for secondary trading. This will contribute to increasing the efficiency of Islamic financial markets. Also, they will provide benchmarks for the pricing of other Islamic financial instruments and the measurement of the performance of Islamic banks."

As interest in Sukuk increases, more countries are lining up to compete to host new corporate Islamic bond issues. The UK is not the only non-Muslim government to be doing so. A significant proportion of international Sukuk issuance to date has been in US dollars, but 14 different countries have performed them in 10 different currencies so far.

The likes of Thailand, Japan and Singapore have raised the prospect of sovereign issuances, while experts are also hoping for the development of a Euro-based Sukuk market, helped by greater activity in the UK.

Edmond Lau, director of monetary management at the Hong Kong Monetary Authority (HKMA), says the country is part of a growing group seeking to introduce Islamic services into their mainstream financial systems.

He hopes to have the necessary regulatory framework ready "within months... The Islamic financial services industry, however substantial it already is, has not been growing fast enough to match growth in Islamic wealth. It therefore calls for new entrants into the market.

"Our objective is to make Hong Kong a platform for wholesale Islamic financial activities. We are trying to nurture a level playing field so that Islamic financial transactions can take place in Hong Kong."

By preparing the ground for Sukuk issues, countries like the UK and Hong Kong hope to tap into Middle East wealth and regional investors' ongoing need to diversify their investments.

As evidence of growing ties between the Gulf and Far East, Lau cites an Economic Intelligence Unit (EIU) survey of Middle East financial service professionals, in which over a fifth said they expected Asia-Pacific to account for the largest portion of equity investment from their clients within three years.

The HKMA aims to use Sukuk to provide Gulf investors with better access to China's growth market, particularly the numerous 'red chip' companies from the mainland that are listed in Hong Kong. Lau points to the success of a recent Malaysia-based issue that was linked to some of these firms.

Nasser Al Shaali, CEO of the Dubai Islamic Financial Centre Authority (DIFCA), which has partnered with Malaysia and Hong Kong on Sukuk rollouts, argues that "the centre of gravity in capital markets is shifting eastward". He says: "There has been tremendous wealth accumulation in the last 10 years and multinational companies are locating in the Middle East and Asia in reverse globalisation.

"More and more countries are putting their hats in the ring to compete in the Sukuk market. This competition between cities is generally very good. It will help develop the industry, innovation in products and services and it will help foster more work in standardisation."

Back in the UK, the government is grappling with the complications of enabling its Sukuk market to flourish amid this level of competition. It has been encouraging the development of Islamic financial services for years, and recently assumed powers to introduce new guidelines to encourage corporate Sukuk issuance.

But discussions continue around issues such as stamp duty and VAT. Any changes, experts say, are likely to be introduced in the UK's Finance Bill 2009.

Some have suggested that political concerns have persuaded the government to back-pedal on the Sukuk issue, but this was denied by a Treasury spokeswoman: "We're not suggesting that Britain will be ruled under Islamic law. We are working towards creating a Sukuk issuance that would allow people, regardless of their faith, to have access to financial services.

"We see it as an opportunity to enhance London's position as a global financial centre. We see it as an opportunity and a challenge. There are a number of barriers in place, legislative and otherwise, and we need to remove those to create the right environment for the issuance."

Opinion seems to be divided on when the UK government might declare it is ready to do so.

In June, one indication came from the state-owned National Savings & Investments (NS&I), which offers retail banking services based on government bonds.

It pulled back from launching a Sharia-compliant savings product on the back of sovereign Sukuk scheme, saying it would revisit the issue in 18 months "to allow for the launch of the UK government Sukuk, the development of a secondary market for the Sukuk, and to gauge its impact on the development of the Islamic retail savings market".

Some observers say an announcement could happen sooner; at the UK's Pre-Budget Report in August, while others say it may not take place until early 2009. Already, some industry players are said to be preparing strategic alliances to win management contracts for the Sukuk.

But some say the government should delay the move until there is more clarity over the potential depegging of GCC currencies from the dollar, or until international economic conditions improve.

Faisal Hijazi, an analyst at Moody's, says: "Governments, including the UK, Japan and Hong Kong... will have to work on a number of structuring, regulation and taxation issues before a Sukuk issuance can proceed. Moreover, for the time being, the status of the credit market conditions delay immediate issuance plans."

In public, however, the government says it remains committed to the Sukuk scheme. Kitty Ussher, the Economic Secretary to the Treasury, who is overseeing the consultation process, says there are "lots of issues to think about" but that the government is "proceeding as fast as we can".

The Treasury spokeswoman adds: "Some people think that things aren't happening, but they are. We do have to go through the process of creating the right environment and we have some work still to do.

"But Kitty Ussher is very supportive of the sovereign issue," she continued. "She wants to go all the way."