The report by the Food Standards Agency (FSA) marks an attempt by the regulator to cater for an ethnic dish, rather than fight the practice with law.
However the FSA warned that it will continue to ban the practice until its analysis of ways to produce the meat safely is completed.
The agency also held out the possiblity that if the production methods are valid it could go to the European Commission to gain approval for 'skin-on' sheep products.
"One way of combating the current illegal trade in smokies would be to make their production legal in licensed slaughterhouses, and thus enable consumers and the farming community to benefit from the apparent demand for the product," the FSA stated in releasing details of the report.
The popular west African delicacy is prepared by blowtorching a sheep carcass while the skin and fleece remain attached.
The method gives the meat a golden appearance and a strong smokey taste.
The practice, often done by farmers in a shed, is illegal because there is no official supervision of the production, breaking food safety laws..
The FSA commissioned Bristol University Veterinary School to do the research into 'skin-on' sheep after several sheep farmers were caught supplying the market.
Demand for the 'skin-on' sheep, which has a golden appearance and a strong smokey taste, is rising in the UK and the potential health risks associated with the practice have not diminished its popularity.
According to the FSA the meat is currently produced in unlicensed premises with no Transmissable Spongiform Encephalopathy (TSE) controls in place or official supervision.
Indeed, some reports suggest that demand is so high that meat, smuggled into the UK from Africa, can change hands for up to ten times the its normal price.
The agency said that smokies may pose a significant risk to human health because the method in which animals are slaughtered could cause contamination by faecal material, resulting in the presence of harmful bacteria such as E.coli and salmonella.
Furthermore, there are also concerns about the health hazards of consuming residues from veterinary medicines applied to the skin and fleece, which may not have been washed.
The final report was given to the agency in December 2006.
A scientific paper of the main findings, submitted to an unnamed peer-reviewed scientific journal, concludes that 'skin-on' sheep meat can be produced hygienically, under certain conditions.
The report also provides evidence to support the development of a meat inspection protocol, the FSA stated.
Research has also been conducted to examine the medicines applied to the skin and fleece of sheep, which are needed to control parasites and flies.
The separate study, which looks at how the withdrawal period for the treatments was calculated, could provide the FSA further information on the safe production of smokies.
Currently withdrawal periods could ensure residues are below a 'safe' limit, but the existing calculations may have been made based on skinned, and therefore, legal sheep, the FSA stated.
The regulator said it was too soon to speculate if it will be in a position to approach the European Commission to have the law changed, enabling legal production.
The FSA said there is no prospect of the law being changed in the short term.
As a result, the practice will continue to operate illegally with FSA working with local authorities to ensure the law as it currently stands, is enforced.