Under the new mechanism, all short-selling transactions by institutional investors will be electronically processed and then filtered through a central detection system set up at the stock exchange operator to prevent illegal trades, the Financial Supervisory Service (FSS) said in a statement.

In South Korea, naked short selling of stocks, in which an investor sells shares without first borrowing them or determining they can be borrowed, is banned by the Capital Markets Act.

In remarks prepared for a discussion forum on Thursday to explain the new system to market experts and retail investors, FSS Governor Lee Bok-hyun said: "Illegal short selling has been one of major factors behind the Korea discount by undermining market credibility among domestic investors."

"With this double-layered checking system working properly, we hope that it will root out illegal short selling," Lee said.

South Korea is making various reform efforts to resolve the so-called "Korea discount" in the domestic stock market, a tendency for domestic companies to have lower valuations than global peers due to factors including low dividend payouts and opaque governance structures.

Last November, South Korea imposed a sudden ban on short selling of shares through the first half of this year after it found illegal trades by several foreign investment banks. Financial authorities have since said the ban would stay in place until there are adequate measures prepared to prevent the practice.

South Korea has also proposed to loosen stock short-selling rules for retail investors, while introducing a new borrowing limit for institutional and foreign investors once their ban is lifted, to promote a "level playing field" in the market.

The FSS said in the statement it would implement the new monitoring system after finalising it in a speedy manner, without providing a date.