Top banking supervisors have put hedge funds - well known players include Soros, Michael Steinhardt and Paul Tudor Jones - high on the agenda for their meeting in Basle in two weeks. The US Federal Reserve is particularly concerned about the funds' activities following last week's collapse in world bond markets and the recent strength of the yen.
The French and German central banks are also keen to tighten controls, and the Bank of England has been studying the area for two months.
Selling of hedge funds, which are designed to limit risk through investment in futures and options, precipitated virtually unprecedented falls in the European bond markets last week. The War Loan, an undated gilt, has fallen 11 per cent in the last month, its largest monthly fall since 1974.
World financial markets are braced for further turbulence this week, with investors fearful that heavy selling by international speculators carrying severe paper losses is far from over.
Analysts said the markets would initially take their cue from yesterday's meeting of the Group of Seven finance ministers, who were set to soothe rattled nerves with a signal that inflation pressures are subdued in Europe and firmly under control in the US.
The ministers, and their central bankers, met at Kronberg, in the Taunus hills near Frankfurt. Despite indications they were prepared to calm bond markets down, further selling pressure from the hedge funds, which take big speculative positions financed by high levels of borrowing, may frustrate them.
Analysts predicted that institutional investors, such as pension funds, with high levels of liquidity, were ready to buy both bonds and shares. But these investors are wary of making a move while uncertainty hangs over the hedge funds, which control up to dollars 45bn of speculative positions in several key markets.
When they meet in Basle, the supervisors of the top central banks will look at a range of options. At one extreme, they could insist that banks deduct the value of any loans to hedge funds from the capital they are required to hold to insure against bad debts. This would make it prohibitively expensive for banks to lend to hedge funds, and would in turn limit one way funds build up massive positions in futures markets.
Central banks are also determined to limit banks' exposure to hedge funds through trades in financial derivative instruments, such as traded options and financial futures, and by way of trading in conventional securities and bonds.
Banking supervisors have been rigorously examining commercial banks' exposure to hedge funds, which has ballooned over the past year. They regard them as particularly dangerous because many are based in largely unsupervised tax havens in the Caribbean. As a result there is no way of determining total risk exposure.
Ian Plenderleith, an associate director at the Bank of England, highlighted the issue in a speech last week.
But to date, Bank of England supervisors have limited their actions to suggesting that banks do a little business with a few hedge funds rather than taking the risk of doing a lot with one.
Hedge funds have experienced a very volatile month. Markets have moved substantially against them and some US funds have made large losses. Stanley Druckenmiller, manager of George Soros's dollars 3bn flagship Quantum Fund, confirmed it had lost dollars 600m in a single day recently. By contrast it made a dollars 1bn profit when sterling fell out of the Exchange Rate Mechanism in 1992.
Hedge funds have fed the volatility of bond markets by borrowing money to buy bonds 'on margin', allowing them to put up only a small part of the money at risk.
This practice potentially allows a dollars 1bn fund to take total bets of perhaps dollars 20bn. But when the markets fall sharply, the funds are forced to sell a disproportionately large amount of bonds to cover their losses.
Last Friday the Quantum Fund is understood to have placed an order to sell dollars 4bn worth of German mark bonds.
According to published figures, Willowbridge International, one of the smaller US funds, has lost 22 per cent of its value (measured in dollars) so far this year, more than any other. Michael Steinhardt's SP International A fund is down 13 per cent. But the Quantum Fund is almost even, despite its big one- day losses.
Part of the reason that gilt- edged stock prices fell further than other European bond prices last week was a warning from the Japanese house Nomura that UK base rates might jump to between 6 and 7 per cent by the year-end.
However, the Chancellor of the Exchequer is still keen to cut rates further and may decide on another quarter-point reduction in base rates, from the current 5.25 per cent, when he meets the Governor of the Bank of England on Wednesday to discuss monetary policy.
At their last meeting the Chancellor pushed for a half- point reduction, but the more cautious Bank persuaded him to settle for a quarter-point cut on 8 February. The move, coming just days after the first rise in US interest rates for five years, unsettled markets.
Recent turbulence in the stock market is causing some leading securities houses to reconsider the timing of the welter of new issues planned for the coming months. Up to 80 companies were expected to take advantage of previously bullish conditions to raise new finance during the next four months.
Some bankers said last week that they would not be surprised if a handful of new issues were postponed or scaled down. Some floats in the pipeline might be cancelled.
Last week produced an early sign that the new-issue appetite might be waning. Applications for shares in Goldsborough Healthcare came in undersubscribed, at 98.1 per cent. Analysts said this was as much to do with the pricing as with market conditions.
Attention will now turn to Graham, the builders' merchant being floated by BTR. Applications close on Wednesday.Reuse content