Bank of Korea, FSS launch joint forex inspection targeting NDF speculation

South Korea's foreign exchange authorities are launching a joint inspection targeting non-deliverable forward (NDF) trades as the won-dollar rate continues to surge amid external pressures — including expectations of US interest rate hikes and uncertainty over a US-Iran end-of-war deal. The move aims to tighten surveillance of won-weakening bets and market-disrupting activity. Authorities also said they would review measures to improve NDF transparency and draw offshore transactions back into the domestic market.

The Bank of Korea and the Financial Supervisory Service announced Wednesday they will conduct a joint foreign exchange inspection of major foreign exchange banks. The inspection follows an emergency market review meeting held Sunday and will combine document-based and on-site examinations.

The inspection will focus on whether foreign exchange banks engaged in conduct that undermines foreign exchange market stability — including attempts to move or fix exchange rates for the purpose of gaining improper profits or enabling third parties to do so.

The scope of the review includes trades executed with the intent to disrupt market function or interfere with price discovery, as well as one-sided transactions placed at specific times in volumes exceeding customer orders with the aim of moving prices against those customers. These are among the representative examples of market manipulation defined under Article 4 of the Seoul Foreign Exchange Market Code of Conduct.

Authorities are focusing on NDF trades because they believe a significant portion of the won's recent weakness has been driven by the offshore market. The won-dollar rate has repeatedly made large moves during overnight London and New York trading sessions, fueling market concerns that won-weakening bets through NDF instruments may have amplified one-sided exchange rate moves and broader volatility.

NDFs are derivatives that settle only the difference between the contracted and spot exchange rates in dollars, without any actual exchange of won. Because large positions can be built with relatively small margin requirements, they have long drawn criticism for their potential to amplify exchange rate volatility.

The Bank of Korea and the FSS said they will take stern measures under applicable laws if any violations are confirmed. Under the current Foreign Exchange Transactions Act, manipulating or fixing foreign exchange rates for improper gain carries a penalty of up to five years in prison or a fine of up to 500 million won (about $329,000).

The government is also reviewing ways to redirect NDF activity into the domestic foreign exchange market while closely monitoring NDF trading trends. The goal is to reduce reliance on the relatively opaque offshore market and expand domestically centered trading to ease exchange rate volatility.

Ahn Do-geol, a Democratic Party of Korea lawmaker and floor leader of the party's special committee on economic responses to the Middle East war, told reporters after the committee's sixth plenary session Wednesday that authorities had agreed to develop measures to improve NDF market transparency and gradually absorb it into the domestic foreign exchange market. He added that the committee would also actively review improvements to foreign exchange regulations — including easing foreign currency liquidity stress test standards and extending exemptions from the macroprudential levy — to help private financial institutions expand their overseas dollar funding capacity.

Ahn also said the national pension fund is the single largest player in the domestic foreign exchange market, and that the committee would accelerate institutional reforms to diversify the fund's overseas investment financing. Those measures include issuing overseas bonds, securing foreign borrowings and expanding foreign exchange swap arrangements to spread out the concentration of dollar demand in the domestic market.

The government and financial authorities have been issuing daily market stabilization messages as the won-dollar rate has surged in recent days. On Sunday, the heads of four major institutions held an unscheduled emergency market review meeting and pledged a firm response to speculative trades and market-disrupting activity. The Financial Services Commission followed up Monday by summoning representatives from commercial banks and foreign bank branches to urge them to strengthen internal controls against market manipulation.