Britain's push to promote itself as a leading Islamic finance hub comes as competition heats up with other financial centres in Asia, led by Malaysia, and in the Middle East.
Britain first announced plans for a sovereign sukuk five years ago but that issue never materialised as the country's Debt Management Office decided the structure was too expensive.
The new proposal is less than a fifth of the size of the original and is designed to boost London's status rather than to diversify Britain's investor base.
"I don't just want London to be a great capital of Islamic finance in the Western world, I want London to stand alongside Dubai and Kuala Lumpur as one of the great capitals of Islamic finance anywhere in the world," Cameron told the World Islamic Economic Forum being held in London.
Sukuk are investment certificates which follow religious principles such as a ban on interest and gambling.
The global Islamic banking industry is expected to tip $1.8 trillion by the end of this year, according to consultancy Ernst & Young, and is starting to attract interest among big Western banks because of rapid growth of trade involving wealthy Gulf economies.
Malaysia, the world's largest marketplace for sukuk, is shifting efforts from local market development towards attracting global issuers, while Dubai is revising regulations to attract sukuk issuance and trading.
Britain is the European base for several Middle East banks and a major centre for Middle East investors, whose assets include Harrods department store and Manchester City football club.
London has sukuk legislation in place and has attracted more than $34 billion in sukuk listings from around the globe over the last five years. Sizeable issuance from local firms, however, has remained elusive.
The government sukuk, by enhancing London's status as an Islamic finance hub, should not stumble on the Debt Management Office's "value for taxpayer" objective, a test which the original plan of five years ago failed.
"The government was previously looking at a relatively large programme of sukuk issuance as part of its regular financing programme, but has now changed its strategy to look at a more modest sukuk issue in order to derive wider benefits such as instigating activity in the Islamic finance industry," a Debt Management Office spokesman said.
A smaller issue was also more likely to be cost effective, he added.
The investment-grade sukuk would be welcome news for local lenders which could use it as a liquidity instrument, said Richard Williams, finance director at Bank of London and the Middle East, the UK's largest standalone Islamic bank.
"This challenge will now be resolved and is one of the final measures in creating a truly level playing field for the UK Islamic banks," said Williams.
The London Stock Exchange also announced plans to launch an Islamic index which would identify companies which are filtered according to Islamic principles, which work in much the same way as socially responsible screens.
Islamic investments have already been used to finance London landmarks such as the Shard skyscraper and the Olympic Village.
The World Islamic Economic Forum is hosting its ninth annual conference in London this week, the first time it has been held in a non-Muslim country.
(Reuters / 29 Oct 2013)
Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com