G8 summit to call for hedge fund vigilance

PARIS, June 4 (Reuters) Leaders of the G8 powers will call this week for greater vigilance on hedge funds in the hope that the industry will take it upon itself to prevent accidents like the collapse of LTCM in the late 1990s.

The call, to be made at a summit hosted by German Chancellor Angela Merkel, falls way short of Berlin's attempt to crack down on an industry which has blossomed in recent years in the shade of mainstream funds and banks, which are more closely regulated.

''It's the first time the call has been made by a G8 summit, so it's significant in itself,'' said one official involved in negotiations for the gathering in Heiligendamm on Germany's Baltic coast, taking place from Wednesday to Friday.

A statement to be published at the summit says G8 leaders -- from the United States, Japan, Germany, Britain, France, Italy, Canada and Russia -- prescribes ''greater vigilance'' and better efforts to improve the transparency of hedge funds.

Once solely reserved for millionaire investors, hedge funds are now a major source of profit for more traditional financial institutions such as banks, raising two key questions about the risks of funds that use high-risk investment strategies: Would a hedge fund crisis pose a systemic risk for the rest of the financial system? Should investor protection be improved as hedge funds forge closer links with banks and pension funds which invest for people well below the millionaire bracket? Berlin tried on several occasions in recent months to win G8 support for tighter regulation of hedge funds or, short of that, a code of conduct.

Finance Minister Peer Steinbrueck said after a meeting of G8 finance ministers in Germany last month that he still believed a code of conduct would one day apply, if not in the near future.

He has received little backing since then from France or Italy and failed to overcome outright opposition from Britain and the United States, fans of a more hands-off approach.

''It's gone nowhere,'' a second official said. Both officials who spoke to Reuters did so on condition of anonymity because of the sensitivity over the statement set to be published in the G8's name in Heiligendamm.

BAD IMAGE One bad memory that haunts governments and regulators is the demise of Long-Term Capital Management (LTCM), which was a huge profit-spinner until it got burned in the financial crisis when Russia defaulted on its debt in 1998.

The US Federal Reserve had to orchestrate a multi-billion dollar bailout for fear that the fund's implosion would trigger a chain reaction in the financial system more generally.

Since then, the hedge fund industry has bounced back, aided by five years or so of strong economic growth and low interest rates that spurred the quest for bigger returns.

Business has expanded five-fold with assets of $1.6 trillion under its management, according to a report commissioned by G8 governments from the Zurich-based Financial Stability Forum.

Washington and London argue that less ritualistic but more real-time and continuous contact between supervisors and hedge funds will be more effective in detecting potential trouble.

REUTERS AE ND1632