Britain's first Islamic bond draws torrent of bids

* UK becomes first Western country to sell Islamic bond

* Five-year sukuk attracts 2.3 bln stg in orders

* Sukuk offers same return as 5-year conventional gilt

* Finance minister, banks hope will spur corporate issuance

* UK debt agency plans no further sukuk issuance (Adds finance minister and BLME Islamic bank comment)

By David Milliken

LONDON, June 25 (Reuters) - Britain became the first Western country to sell an Islamic bond on Wednesday, attracting 2.3 billion pounds ($3.9 billion) in orders, more than 10 times the amount it was looking to sell.

The government raised 200 million pounds from the five-year sukuk issue, part of an effort to boost London's position as a centre for Islamic finance.

Finance minister George Osborne said he hoped the deal would spur more corporate issuance of Islamic bonds, which cannot pay interest but instead offer a fixed profit stream based on underlying assets such as property.

"Today's issuance of Britain's first sovereign sukuk delivers on the government's commitment to become the Western hub of Islamic finance and is part of our plan to make Britain the undisputed centre of the global financial system," he said.

The Islamic bond was priced to give a profit rate of 2.036 percent, the same as the yield on Britain's benchmark five-year government bond, or gilt. That is less than the premium of up to 2 basis points over the conventional bond that was initially indicated, reflecting bumper demand.

However, some analysts questioned whether the relatively small issue was enough to kick-start Britain's Islamic finance market.

Robert Stheeman, chief executive of the UK Debt Management Office, told Reuters that it had been hard to find suitable assets to structure the issue, which does not pay interest in the same way as a conventional bond.

"At this stage it's planned just to be a one-off," Stheeman said. "It has not proven easy to find sufficient assets either for bigger size or for a programme of issuance. But we are pleased with the result."

The sukuk is underpinned by rents from three government buildings.

Earlier in the day, speaking at a Euromoney conference, Stheeman described the bond sale as an essentially political decision and not a way to meet core British funding needs.

STRONG DEMAND

The strong demand belies concern from some analysts that the low yield for the 2019 sukuk, and the use of sterling, might have dampened its appeal to overseas investors, who are used to higher yields and other currencies.

However Khalid Howladar, Moody's global head of Islamic finance, said that the "modest" 200 million pound sukuk issuance "really doesn't move the dial in terms of the $60-65 billion in global sukuk issuance expected this year."

"Demand for high credit quality sukuk in the triple-A and double-A space far exceeds supply, particularly among the fast growing Islamic banks who need an increasing amount of high grade assets to address forthcoming Basel III liquidity requirements," he added.

Britain said that the sukuk was bought by banks, central banks and sovereign wealth funds based in Britain, the Middle East and Asia.

Around a third of the issuance went to Islamic banks operating in Britain, for whom this is a rare chance to buy sterling-denominated sukuk assets.

The Bank of London and the Middle East (BLME), Britain's largest stand-alone Islamic bank, said it was satisfied with its allocation, considering the high demand.

Its chief executive, Humphrey Percy, told Reuters that the sukuk was likely to be relatively illiquid when it starts to trade on July 2, as the scarcity of the debt meant most investors intended to hold the bond for the long term.

But he said the strong demand should boost corporate issuance of sterling-denominated Islamic debt in London.

"It is hoped that the high level of demand ... will demonstrate to large UK corporates that Sukuk is a viable and competitive method of fund raising and directly comparable in pricing terms to the conventional bond market," he said.

British bank HSBC structured the sukuk deal, and acted as a bookrunner alongside Qatar's Barwa Bank, Malaysia's CIMB, National Bank (NYSE: NBHC - news) of Abu Dhabi and Standard Chartered (HKSE: 2888.HK - news) .

Law firm Linklaters provided legal advice. ($1 = 0.5892 British Pounds) (Additional reporting by Archana Narayanan, Ana Nicolaci da Costa and Andy Bruce and Bernardo Vizcaino; Editing by Catherine Evans/Ruth Pitchford)