South Korea is in the final steps of testing a new monitoring program designed to detect the illegal short-selling of domestic stocks before it removes a total ban on short-selling at the end of March.

The country’s sole bourse operator, Korea Exchange, said it completed the development of a "naked short-selling detecting system," also called NSDS, which identifies illegal activities by comparing the balance information submitted by institutional investors with their transaction history collected by the KRX.

Starting Monday, it also began a test run with 30 domestic and foreign institutional investors who established their own balance management systems that manage available-for-sale securities to be linked with the NSDS.

Separately, Korea’s financial regulator, the Financial Supervisory Service, said Monday that it will start to issue registration numbers for entities dealing with short-selling trades from Tuesday as a part of the KRX’s central detection system.

Institutional investors with a net short position balance of 0.01 percent, or 1 billion won or more, are eligible to obtain the registration number.

“The registration system is expected to improve transparency in short-selling transactions by allowing only investors of substantial size to engage in large-scale short-selling transactions,” the regulator said in a statement.

The NSDS is expected to use the registration numbers to thoroughly monitor illegal short-selling by tallying all transaction details for each firm.

The current complete ban on short-selling is set to be lifted on March 31 for the first time in the roughly 17 months since the restriction was first imposed in November 2023 after the discovery of illegal trades by several foreign investment banks.

Short-selling involves borrowing and selling stocks expected to decline in value, and repurchasing them at a lower price to profit from the difference. Naked short selling, where stocks are shorted without borrowing or confirming their availability, is illegal in Korea.

The KRX plans to continue refining the interface and data consistency of the NSDS until February. A mock market will be operated starting in March for institutional investors that have completed the test.

“By building a computerized system for short-selling, we will be able to prevent illegal short-selling transactions and improve market confidence,” the bourse operator said.

Korean financial authorities have been asserting that illegal short-selling is one factor behind the "Korea discount," a term used to describe the lower valuation of Korean stocks compared to their global peers.

“Unfair trading activities in the capital market are a major factor in the Korea discount, which undermines market credibility,” Korea Exchange CEO Jeong Eun-bo said on Jan. 2 during the opening ceremony of the stock and derivatives market for 2025.

“We will create a market environment in which investors can trust and invest by improving the market monitoring infrastructure such as NSDS and the next-generation surveillance system, and quickly removing insolvent listed companies,” he said.

Ahead of the resumption of short-selling in March, the government also revised related regulations.

Financial authorities decided to limit the term of securities lending and borrowing transactions for short sale to 90 days from the execution date. Previously, there was no limit on the repayment period when borrowing stocks.

By Park Han-na (hnpark@heraldcorp.com)