THE government is coming under growing criticism from leading fund managers over the way it forced the Serious Fraud Office to drop its investigation into arms sales to Saudi Arabia.

The decision, which was announced earlier this month, means there will be no more probing into allegations of corrupt practices at BAE Systems in relation to the Al Yamamah oil-for-arms deal, struck in the 1980s.

Now a number of fund managers say that this could compromise London’s standing as a financial centre. Hermes, Britain’s top fund manager and a champion of corporate governance, is the latest investor to add its voice to the criticism.

Hermes is asking other institutions to speak out. In a letter sent to Tony Blair it said: “Lack of credibility in the regulation of one company can spread to the rest of the stock market, creating higher-risk premiums and cost of capital.”

Last week F&C Asset Management also wrote to Lord Drayson, the defence procurement minister, setting out its concerns.

It said: “As a long-standing advocate of strong corporate governance and anti-corruption standards, we place great value on the actions that governments take to ensure the investment climate is marked by clear, predictable standards and independent enforcement of the rule of law.”

F&C added: “There is a danger that the government’s recent action will be perceived as undermining the consistent application of the UK’s national legislation governing corrupt practices, precisely at a time when wider take-up of the OECD (Organisation for Economic Co-operation and Development) convention is beginning to take root.”

Senior government officials were concerned that, if the SFO pursued the case and bought charges, it would have jeapordised at least 50,000 jobs — both directly and indirectly — in Britain’s defence industry. The Saudis had threatened to withdraw co-operation on security and cancel a supply contract for Eurofighter Typhoons.

BAE has consistently denied allegations of corruption which date back to a 20-year-old oil-for-arms deal.

Lord Goldsmith, the attorney-general, asked the SFO to drop the investigation on the grounds that it threatened national security. Since the decision was announced, shares in BAE have had a strong run, closing last week at 419p. This values the group at £13.5 billion.

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