But he called on the department to make a formal apology and implement changes to ensure others do not have to experience what he went through.
Mr Hedges was detained in Abu Dhabi between May and November 2018, after being accused of working for MI6.
He had travelled to the UAE to carry out research for his PhD when he was arrested at Dubai airport.
Mr Hedges later described how he was questioned for up to 15 hours a day, forced to wear ankle cuffs, faced sleepless nights, post-traumatic stress disorder (PTSD) and was reliant on a cocktail of drugs that were fed to him in jail.
Mr Hedges, originally from Exeter, was sentenced to life imprisonment but was pardoned by the nation’s president days later.
He complained to the PHSO that the Foreign Office had failed to notice he was being mistreated.
The PHSO, an independent service which examines unresolved complaints against UK Government departments, has now concluded the UK failed to follow its own guidance on detecting potential torture and mistreatment of British nationals.
The PHSO said embassy staff noted Mr Hedges’s voice was shaking when they visited him, he avoided eye contact and mentioned having anxiety attacks.
It added these were signs he might have been subject to torture or mistreatment, and that Foreign Office guidelines say that staff should have acted in response even when they do not have consent.
The PHSO recommendations included asking the Foreign Office to make a written apology to Mr Hedges, plus make a compensation payment of £1,500, within a month of the final report.
Mr Hedges told BBC Radio 4’s Today programme: “This is the first step in enabling me to truly heal.”
He added: “I wouldn’t turn down financial compensation but of course £1,500 is a paltry sum by comparison.
“But first and foremost the most crucial thing for my recovery is a formal apology from the Foreign Office and for them to acknowledge and to implement changes so that other people who are currently or have been in similar circumstances don’t have to endure this.”
PHSO chief executive Rebecca Hilsenrath said: “It is hard to imagine the experience that Mr Hedges has endured and quite how terrifying his detention must have been.
“The nightmare was made even worse by being failed by the British Government.
“He trusted them to help him and they let him down. Officials failed to notice signs of torture, failed to intervene and failed to help.
“At the end of the day, the role of the Government is to protect its citizens and this was a profound failure.
“The impact will run deep for Mr Hedges and he will have to live with that for the rest of his life. This must not happen again to anyone else.
“We have asked the FCDO to make sure it will fully use all its powers to protect British citizens abroad, and ensure that they are there precisely when they are most needed.”
A Foreign, Commonwealth and Development Office spokesman said: “The best interests of British nationals, including those detained overseas, is at the heart of our consular work and we support their families wherever we can.
“We will review the ombudsman’s findings and respond in due course.”
A statement from the UAE government said: “Matthew Hedges was convicted of espionage in 2018 following a fair and transparent trial at which he admitted the charges against him.”
The UAE government said they provided Mr Hedges with “entirely proper care and treatment”.
The statement added: “He was never subjected to, or threatened with, either torture or cruel, inhuman, or degrading treatment of any sort. The UAE has evidence to support this.”