Dubai World's restructuring will see firms take a hard look at Middle East strategy

It was already looking somewhat strained, but now the West's love affair with the debt-fuelled desert oasis of Dubai has come to an abrupt halt. While the initial panic in response to the Dubai Government's decision two weeks ago to ask creditors for a debt standstill on the obligations of Dubai World has died down, there is no doubt the emirate's reputation as a business centre has taken a knock.

The ability of Dubai-related entities to tap the capital markets will also be severely curtailed in future unless the Dubai World debt restructuring suddenly starts going a lot better than looks likely. The episode will also do long-term damage to the emirate's hope of establishing itself as a major financial centre. This issue is of particular importance to law firms, which have been ploughing resources into Dubai for the last five years, leaving this small but highly-concentrated economy with a very heavily lawyered market. The worse case scenario, some argue, will see firms pulling out of Dubai altogether to focus on more stable, oil-rich markets like Abu Dhabi, Qatar or Saudi Arabia.

There has been talk from Dubai-based advisers to the effect that this whole episode has been exaggerated by foreign media and naive creditors and that this outcome was always on the cards. That seems a rather convenient rewriting of history, given that Dubai officials had been widely reported as indicating for months that they would make good on debt obligations. Likewise, those pointing out that the quasi-state guarantees are not as good as explicit Government backing are reaching. Implicit guarantees can be broken – so can explicit ones – but there are always consequences.

Not all Middle Eastern advisers are so sanguine on Dubai's woes. A number have always thought it a rather unstable market, dominated by property speculation and excess in comparison to markets like Abu Dhabi. Others argue the main value of being in Dubai is to get outbound investment work.

The more committed firms who have been there for some time have spread their Middle East interests across the region, but the firms that will struggle will be those who have bought in big teams and are too heavily focused on Dubai alone, a camp in which many put DLA Piper. The firm, which was until recently heavily reliant on Dubai World property developer Nakheel, this week announced its third round of redundancies in the region.

Aside from the impact on the Dubai market, the attempt to restructure Dubai World's debt obviously throws up high stakes issues. For one, the UAE has no sophisticated insolvency laws set up to deal with such a situation. Likewise, the restructuring, which includes the $3.5bn (£2.1bn) bond issued by Nakheel, will be the first time a Sharia-compliant security has been tested in default or something that looks a lot like it. A messy outcome on resolving this – which will be complicated by the lack of standardisation inherent in Sharia law vehicles – would be the first major stress test the Islamic finance market has faced.

Advisers on Dubai World's restructuring can at least look forward to a groundbreaking and sizeable mandate, in particular Latham & Watkins and Clifford Chance, respectively advising the Dubai Government and Dubai World. Creditors counsel like Allen & Overy and Denton Wilde Sapte will want to tread carefully as the Dubai authorities are not known for taking kindly to an aggressive stance. A number of legal advisers are believed to have passed on the bondholder mandate that Ashurst has taken, which shows that some law firms still think Dubai is worthy of long-term investment.