HEDGE funds are creating a “major risk” to global financial stability, although there may be little that can be done to tackle the problem, the European Central Bank suggested yesterday.

In one of the starkest warnings yet from an official institution over the role of the burgeoning but secretive industry, the ECB sounded a note of alarm over the possible repercussions from any collapse of a hedge fund, or group of funds.

In its twice-yearly Financial Stability Review, the Frankfurt-based central bank also raised serious concerns over many hedge funds’ growing use of “increasingly similar” trading strategies.

It argued that this trend could lead to worldwide liquidity problems if a financial or economic shock led funds simultaneously to attempt to alter their trading positions.

The ECB suggested that the herd instinct among hedge funds posed “a major risk for financial stability, which warrants close monitoring, despite the essential lack of any possible remedies”.

In an assessment that underlined its anxieties over the spread of hedge funds, the ECB also said that it believed that the “idiosyncratic collapse” of a key fund, or of a cluster of smaller funds, posed as great a risk to financial stability as a bird flu pandemic. It said both raised the threat of significant disruption to financial markets — an analysis which raised the spectre of the 1998 collapse of LTCM, the US hedge fund bailed out in a rescue orchestrated by the Federal Reserve.

Despite its concerns, the ECB stopped short of calling for more direct hedge fund regulation. It said that it believed indirect regulation through regulated financial institutions was still the best course.

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