DUBAI - The sukuk market will likely a see significant reduction in issuance volumes in 2020 as lower oil prices and the novel coronavirus hurt key sectors in core Islamic finance countries, S&P Global Ratings said on Monday.

Most government issuers in core Islamic finance countries may turn to conventional bonds rather than sukuk, because sukuk issuance is more complex and there is increasing risk-aversion among investors, S&P said.

S&P expected 2020 sukuk issuance to total $100 billion at best, down almost 40% from 2019, on the back of muted economic performance in the market's core countries as they take measures to combat the spread of the coronavirus.

Several countries have taken measures to "unlock banking sector liquidity", the ratings agency said, making potential issuers turn to banks rather than the sukuk market.

"We observed an increase in the share of foreign currency issuance in the first quarter, however. This is primarily due to the sharp increase in sukuk issuance in foreign currency in Saudi Arabia, while in other markets it remained stable or declined," S&P said.

"We understand such issuances stemmed from the proactive sourcing of funds by the Islamic Development Bank and Riyadh Bank before the market turbulence began."

S&P said it expects credit risk to increase sharply.

"Among other things, we might see much higher default rates among sukuk issuers, especially those with low credit quality or business plans that depend on supportive economies and market conditions," it said.

"We expect defaults and the implications for investors will bring the debate on standardization of legal documents back to the forefront."

Sukuk issuers will wait for the best window of opportunity to tap the market this year if they have no alternative, such as loans or conventional bonds.

"The momentum in using blockchain for sukuk and issuing green sukuk will likely slow this year," S&P added, two areas it still expects will play a significant role in opening up the sukuk market when conditions improve.

S&P said the crisis could even lead to developments such as: "social sukuk or a new breed of instruments, for example, one on which the rate of return would decline if the issuer fulfills certain social objectives, such as supporting the healthcare system or helping companies affected by COVID-19 so they don't need to lay off staff."

(Reporting by Yousef Saba; Editing by Kirsten Donovan and Hugh Lawson) ((Yousef.Saba@thomsonreuters.com; +971562166204))