Shariah compliant bonds skirt the Islamic dictum that no interest is to be received from loaning money by linking bonds to an underlying asset, say, real estate, that throws off income. This arms-length strategy is designed to permit Islamic investors to receive money on their investment that is not technically interest. Recently, as pointed out in the Financial Times, there has been growing concern about whether these bonds, called sukuks, are the conservative investment vehicles they were made out to be.
Enter Dubai. It seems as though shariah-compliant bonds issued to expand this Islamic Beverly Hills are deemed to have little asset quality behind them. One bond analyst stated on Friday "We are of the opinion that the underlying assets are worth very little." It appears that the biggest losses may be those investors that held sukuks in Nakheel, whose bonds went from $1.11 to the dollar on Thursday to 85 cents to the 40 cent level Friday.
Bondholders are getting lawyered-up and will likely demand that assets such as the QE2 liner and other so-called investments in entities such as the eclectic Cirque du Soleil be used to buoy the sukuk bonds' underlying value. Whether this will be successful remains to be seen.
In short, unless Dubai or their neighbor Abu Dhabi ponies up with government backing, sukuks as an investment may be in deep trouble throughout the Islamic investment community. So much for trying to do an endaround on a religious principle.