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(Adds details, insurance industry letter, FCA)
LONDON, April 1 (Reuters) - British finance minister George Osborne said on Tuesday he was "profoundly concerned" about the way the financial watchdog revealed news of a review of the insurance sector which caused the share prices of insurance firms to tumble last week.
Osborne said the episode was damaging to both the Financial Conduct Authority (FCA) - which was launched exactly a year ago - and to Britain's reputation for regulatory stability and competence.
In a letter to the FCA chairman, he said the regulator's inquiry into the leak had to be "completely independent" of its top management and that it should look at what disciplinary action should be taken.
"The starting point must be that the FCA holds itself to at least as high standards as it would expect of a listed company handling highly market-sensitive information," Osborne said in the letter which was published on the Treasury's website.
"I expect you and the FCA board to do everything possible to make good that damage," Osborne said.
The events unfolded after The Daily Telegraph published an interview on Friday with a senior FCA official who revealed details of a planned review into part of the insurance sector.
The FCA was going to formally announce the review in its annual report on Monday but shares in insurers fell sharply over fears that profitability would be hit.
The watchdog did not clarify terms of its industry review - which were less wide-ranging than initially expected - until nearly six hours after the stock market opened.
The FCA said it would take Osborne's letter into account as it finalises the terms of reference for the investigation over coming days.
In a statement late on Friday the watchdog said its own board would conduct an investigation and involve an external law firm.
FCA chief executive Martin Wheatley said on Monday that Friday's events had not been the watchdog's "finest hour".
Osborne said an investigation independent of the FCA executive should find out why the announcement of an industry review was given in advance to a single journalist.
It should also determine why the watchdog did not issue a statement on Thursday evening prior to publication of the interview, and determine if markets on Friday were disorderly, as insurer Legal & General described them at the time.
The Association of British Insurers has already asked Osborne for a "completely independent" probe, echoing a call from Andrew Tyrie, the influential lawmaker who chairs parliament's Treasury Select Committee. (Reporting by William Schomberg and Huw Jones; Editing by Pravin Char)