G7 leaders endorse supervisory reform agenda

WASHINGTON (Reuters) - G7 finance leaders endorsed a broad reform agenda for the financial sector in the wake of the subprime crisis on Friday that called on banks to improve stress-testing and fortify access to funding in times of trouble.

Finance ministers and central bankers from the G7 rich nations endorsed a top-level report -- expected to set the agenda for regulatory improvements through next year -- that appeared to spare hedge funds and focus instead on banks, complex financial instruments and credit ratings agencies.

"We expect market participants to address many of the shortcomings that were exposed by recent events," the G7 officials said in a communique, increasing the pressure on credit ratings agencies and banks to remedy some of the root causes of the crisis.

The report was done by the Financial Stability Forum, a group of central banks, regulators and international bodies like the International Monetary Fund, which is expected to propose concrete measures in April.

The FSF paper was not meant to propose concrete solutions but provide a preliminary analysis to allow regulators to understand how stresses in a relatively small part of the U.S. mortgage market ballooned into a global financial crisis.

The FSF, a crisis-prevention group, also called for quick implementation of the latest safety rules for global banks called Basel II, which aims to reward safe practices and punish risky ones with hefty capital charges, sources familiar with the report told Reuters.

But hedge funds, often criticized for murky dealings, seem so far to have escaped regulators' wrath as preliminary analyses of the credit crunch show they did not play a big role.

European Central Bank Executive Board member Juergen Stark, speaking at an event alongside the G7 meetings, said hedge funds were not to blame for the financial market crisis but that they needed to operate more in the open.

Stark said more supervision of hedge funds was not feasible but that regulators could do more to oversee the financial firms that do business with hedge funds.

"What can be done ... is to better regulate or better supervise those institutions that provide the credit lines to hedge funds," he said at a conference during the G7 meeting of finance ministers and central bankers.

The FSF report and Stark's comments come as G7 central bankers and finance authorities debate ways to fortify safeguards within the global financial system following August's market meltdown in the wake of the U.S. subprime lending crisis.

CODE OF CONDUCT

"This recent financial market turmoil was not triggered or aggravated by the hedge funds," Stark said. "Both hedge funds and private equity funds play a positive role in the financial markets."

Hedge funds did not need to abide by one, global regulatory regime but a code of conduct would be an important step toward meeting concerns by people doing business with hedge funds and by regulators charged with ensuring the smooth functioning of the financial system, he said.

"All in all, we need more transparency and the hedge fund industry seems prepared to enhance the code of conduct," he said.

Likewise, the G7 group said it supported clear guidelines for sovereign wealth funds, or state-controlled investment companies operated by countries such as China and Dubai.

U.S. Treasury Secretary Henry Paulson said a discussion of sovereign wealth funds reached a consensus that countries operating such funds needed guidelines to ensure transparency and that they operate strictly for commercial, not political, motives.

More transparency could help to allay protectionist fears about funds investing in key assets in some countries, he said.

"It is extremely difficult to draw a clear line between the interest of the investor on the one hand and the interest of the country for whom it is done," Stark said. "It makes the situation difficult for the countries where the investment is concentrated to identify the strategy."

Separately, British finance minister Alistair Darling said sovereign wealth funds should be welcome everywhere as long as they act commercially and not politically.

G7 policy-makers will meet with their counterparts from countries like Saudi Arabia and China to address the best way to handle the giant state-owned funds, which are now estimated to control more than $2 trillion of assets, as concerns grow that they will go on a shopping spree for Western companies.

Stark said it was important that the opportunity for cross-border investment remained a two-way street. "The principle of reciprocity is key," he said.

(Additional reporting by Francesca Landini and Sumeet Desai)