In light of the remarkable growth of Islamic finance and its ever increasing relevance in the global finance market, as a conduit between oil-rich countries in the Middle East as well as other Islamic countries in Asia and the rest of the world, market participants in South Korea (Korea) are turning their eyes to Islamic finance. To keep pace with global trends and to take advantage of the huge potential for market growth, by becoming a direct or indirect participant in the Islamic finance market, the Korean Government and various regulatory authorities in Korea are making genuine efforts to support such entry, by streamlining legal, regulatory, accounting and tax requirements. However, the non-conventional structures and instruments of Islamic finance present unique challenges that must be overcome before Korea can finally taste the fruits of Islamic finance. In this sense, the time is ripe to evaluate the feasibility of Islamic finance and, in particular, Sukuk in the context of Korean law.

Against this background, this article examines:

Sukuk, which is commonly referred to as "Islamic bonds" but is more accurately described as "Islamic Investment Certificates", is an asset-based instrument that represents an undivided pro-rata ownership (legal or beneficial) of the Sukuk holders in the underlying asset. Unlike debt-based conventional bonds that pay interest, Sukuk is Sharia-compliant and accordingly, returns are paid to investors in line with their proportional ownership in the underlying asset.

For a typical Sukuk transaction, a special purpose vehicle (SPV) is established as an issuing entity for the Sukuk. It issues Sukuk certificates to investors (Investors) for the purpose of raising funds for investment in the underlying asset, through a pre-arranged transaction with the original holder of the underlying asset (Originator). In such a transaction, the Investors that hold Sukuk certificates that represent an undivided pro-rata ownership (legal or beneficial) of the underlying asset are entitled to all proceeds arising from the underlying asset.

Sukuk is often compared to conventional financial instruments. For instance, Sukuk is compared to asset-backed securities, due to its asset-backed nature and the transaction structure, which is similar to that of conventional asset-backed securities. Sukuk is also viewed as being very similar to conventional bonds, except that Sukuk has an added layer of an asset-backed transaction that circumvents the conventional bonds' lack of compatibility with Sharia principles, given their interest-bearing nature. Also, unlike conventional bonds, on maturity or the occurrence of an event of default, Investors are entitled to enforce their rights in relation to the underlying asset. Sukuk can be listed on a stock exchange and settled through a clearinghouse and has a maturity of one to 20 years.

Among the many types of Sukuk that are available, the two types of Sukuk that have recently come into the limelight in Korea, due to their potential relevance and application to the Korean markets, are Sukuk-al-Ijara and Sukuk-al-Murabaha.

Korea has yet to witness its first issuance of Sukuk. There remain many legal, financial, accounting and tax issues that need to be fine-tuned and streamlined before Sukuk can be issued in Korea. Currently, whether a Korean company can resort to Sukuk to raise funds arouses much debate and controversy among legal scholars and practitioners.

The question of whether the issuance of Sukuk is allowed in the context of Korea's current legal regime requires consideration of many legal issues under the Korean Commercial Code (KCC) and the Financial Investment Services and Capital Market Act of Korea (FISCMA).

To justify the issuance of Sukuk under Korean law, the legal nature of Sukuk must be ascertained. However, certainty seems lacking in the current legal environment. There has, so far, been no consensus among legal scholars and practitioners as to whether Sukuk can be classified as one of the types of "investment securities" that a Korean company is permitted to issue under the KCC and the FISCMA.

Further, although Sukuk bears a strong resemblance to conventional corporate bonds under the KCC, the KCC takes an exhaustive approach to defining corporate bonds. Sukuk does not neatly fit into one of the types of corporate bonds defined in the KCC. Whether Sukuk can instead be issued under the KCC is not therefore likely to be answered in the affirmative. In addition, the concept of beneficial ownership (which is commonly used in Sukuk transactions in other jurisdictions) is not recognised under Korean law, which makes structuring more difficult.

Active initiatives for legislative change are currently underway to facilitate Sukuk in Korea. One example relates to defining a new type of investment securities that can be issued by a Korean company. Such investment securities would be defined broadly enough to encompass both Sukuk-al-Ijara and Sukuk-al-Murabaha. If adopted, such legislative change would be a cornerstone for the development and continued evolution of Korea's financial and capital markets, by allowing a listed company in Korea to rely on Sukuk-al-Ijara and Sukuk-al-Murabaha as an alternative funding source. However even before the much awaited legislative change, it would be possible for a Korean company to issue Sukuk through an offshore SPV, as doing so would not be regulated by the requirements of Korean law.

Given the many uncertainties to be resolved and hurdles to be overcome, it is evident that Korea faces a long, tough road to fully embrace the techniques and applications of Islamic finance (in particular, Sukuk). However, some of the much awaited progress is currently underway in Korea, to relax some of the legal and regulatory restrictions. In particular, an amendment of the FISCMA and STTCA is currently being deliberated before the Korean parliament to provide a legal basis for issuance of Sukuk in Korea. There is no doubt that such an amendment, if adopted, would be a step in the right direction.