THE Financial Services Authority has launched a crackdown on insider dealing by investment banks and hedge funds.

In an interview in today’s Sunday Times, Hector Sants, managing director of wholesale and institutional markets at the FSA, states that the City regulator is now proactively targeting institutions that it believes participate in market abuse.

The move represents a notable shift in strategy by the FSA, which in the past has targeted individuals — rather than institutions — who have profited from trading shares after receiving inside knowledge.

The change of emphasis follows a boom in the amount of share trading done by hedge funds and investment banks’ proprietary trading desks. The FSA believes it is people working in these areas who are mainly responsible for pushing up the price of shares in companies about to announce they are in takeover talks.

Sants said: “Institutional abuse is not widespread but there are definitely pockets of unacceptable behaviour.”

Companies that are about to declare profit warnings usually see their share prices fall ahead of the announcements. Traders who are in the know have a big price advantage. Such practices, and the regulator’s inability to do anything about it, have given the City a bad name.

Sants believes much of the abuse arises from traders buying and selling shares on information they have gleaned from trading other asset classes.

In recent weeks the FSA has visited a number of leading investment banks and hedge funds to probe a series of convertible bond issues (debt that can be converted into shares), which it believes may have been at the centre of market abuse.

The FSA is investigating whether hedge funds have profited from inside knowledge of these deals.

The $1,000 billion hedge- fund industry is a big player in the debt market and similar abuses are being investigated by authorities in France and Japan.

“We view hedge funds as an important and useful asset class but there are inherent characteristics of the hedge-fund industry that increase the risk of market abuse by the participants,” said Sants. “The growth of hedge funds has been a structural change in the market. The characteristics of the market have shifted in the past year.”

Sants’s team is also targeting investment banks’ proprietary trading desks, which he describes as “high-risk areas”. But the former high-flying investment banker warned that tackling the abuse would not be a simple task and the number of cases bought by the FSA could actually fall as the enforcement division focused on complex institutional abuse. He said: “Institutional abuse is far more complex and difficult to enforce. We have to clearly demonstrate that people have used non-public information.”

As part of the strategy the FSA is to invest £15m in a new computer system that will monitor trading for sophisticated market abuse.

Last month John Tiner, chief executive of the FSA, launched a wide-ranging probe into London’s hedge-fund industry in response to long-terms calls for the burgeoning sector to be officially regulated.

The FSA is expected to publish the results of the probe in a consultation document later this month, which will set out new reporting and regulatory procedures for the industry.

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