Relief for short-sellers as FSA rules out greater regulation of hedge funds

The Financial Services Authority has declared that it sees no need for greater regulation of hedge funds but says it is exploring options on how these controversial financial investments may be sold to the general public.

The comments came in a discussion paper published by the financial regulator yesterday. Hedge funds have been widely criticised in the past few months for exacerbating share price weaknesses and increasing the volatility in stock markets. These funds typically engage in "short selling" where they sell stock they do not own in the hope of buying it back more cheaply later on.

However, the FSA said it saw no current need for increasing regulation in this area. "We do not see a strong case for increasing the intensity of our supervision of hedge fund managers," it said in the 36-page paper.

But the FSA said it would look at how certain types of funds might be made more widely available to retail investors, even though they carry higher risks. "We could seek to bring certain types of hedge funds within the scope of those funds that we may authorise," it said.

Michael Folger, the FSA's business standards director, injected a note of caution saying there were "legitimate concerns about the comprehensibility to retail investors of the information provided by hedge funds about their activities and risk profiles." If such funds were made more widely available they would most likely be "fund of funds" which operate like investment trusts and offer access to a "basket" of different funds, thereby spreading the risk.

The FSA's soft stance on hedge funds, which mirrors its views on short selling, will be a relief to hedge fund managers who may have feared the introduction of a more draconian regime. However, industry specialists said yesterday that they had nothing to fear from a greater degree of policing. Luke Reeves, associate director of Matrix Securities, said: "We are in favour of more disclosure."

Legal & General, whose chief executive, David Prosser, has campaigned for a tax on short selling, said the key requirement was for a level playing field for hedge fund managers and those running traditional funds. "We want to see greater transparency on who owns what as large short positions can be built up in companies without the markets knowledge," the company said.

L&G said it had no plans to launch hedge funds for ordinary investors. "We are in the mass-market with low-risk, low- charge products. Hedge funds are a bit of a niche market at the moment and we would need to see greater understanding of them by retail investors first."

Fidelity Investments also said it had no plans to launch a retail hedge fund until they were better understood.

To date hedge funds have largely been used by wealthy individuals as many funds require a minimum £100,000 investment. This has enabled rich investors to prosper from falling markets while ordinary investors and pension fund holders have lost out.

The FSA plans to consult with the industry during the next three months and has asked for responses by 29 November. The regulator is running a separate consultation process on the issue of short selling and will hold round table discussions with financial services leaders next month. Sir Howard Davies, chairman, has already ruled out a ban on short selling saying it is a "necessary and desirable underpinning to the liquidity of the London market." However, the FSA does support the view that greater disclosure of the level of stock lending would give the market a way of assessing the level of short selling in individual stocks.

Earlier this week the Bank of England said it supported plans to make short selling more transparent.