Hedge fund practices 'pose market risk'

SOME hedge funds are 'testing the boundaries of acceptable practice with respect to insider trading and market manipulation', the Financial Services Authority warned today.

The findings are contained in the City watchdog's year-long regulatory review of the multi-billion pound industry spearheaded by Hector Sants, FSA managing director of wholesale and institutional markets.

Worries also surface in the report about the increased likelihood of hedge fund managers committing fraud against a background of "light regulatory oversight and weaker control environments'.

But the FSA said it has engaged in 'increased proactive market surveillance' after collating increased amounts of data from hedge funds and prime brokers - the trading arms of investment banks which tend to deal with such funds.

Publication of the review coincides with the release of an FSA consultation paper on how it can increase protection of other savings products. Currently, only professional investors and sophisticated retail clients can invest in funds using hedge fund techniques such as derivatives and 'shorting' - selling borrowed securities in the hope of buying them back at a lower price.

Sants said the FSA viewed hedge funds as a useful 'diversification option' but warned that they 'do pose a risk to the UK's financial markets'. Industry responses are due by 28 October.