Warning sounded on hedge fund surge in China

HONG KONG, May 24 (Reuters) Global hedge funds have invested as much as US billion into China's soaring stock markets, a development that regulators should monitor, according to a report by a mainland think-tank cited in Thursday's South China Morning Post.

The study comes amid media reports that China may triple the amount of funds that large overseas investors can invest in mainland markets, to US billion from US billion, under a qualified foreign institutional investor (QFII) scheme.

''US billion to US billion is a conservative estimate'' of global hedge fund investment in Chinese stocks, said Chinese Academy of Social Sciences researcher Zhang Yuewen, who conducted the study. ''Our regulators should pay more attention to hedge funds.'' China's roaring stock markets -- the main Shanghai index <.ssec> has nearly tripled in the past year -- have led a growing chorus of observers, including former U.S. Federal Reserve Chairman Alan Greenspan, to warn that a sharp drop in mainland share prices looms.

Zhang said overseas hedge fund money might be flowing into China through the QFII programme, as well as through local companies controlled by hedge funds, joint efforts with domestic private placement firms, or through illegal banks, the newspaper reported.

''China should enhance supervision of short-term capital flows and appropriately restrict business between domestic financial institutions and hedge funds,'' Zhang was quoted as saying.

''We don't know much about hedge funds, so regulators should ask commercial banks to reduce direct lending to them,'' he said.

Beijing does not allow domestic hedge funds, although the central bank is studying the issue and drafting rules.

REUTERS DKS PM0751