A top official at the Financial Services Authority on Thursday signalled that the UK regulator was putting valuation practices at the centre of its examination into hedge fund operations.

Dan Waters, FSA director of retail policy, told the National Association of Pension Funds gathered in Edinburgh that the UK regulator had been conducting a review of how hedge fund assets were valued, looking at the frequency of valuations, separation of duties within fund structures and the reliance on third-party pricing systems to verify prices.

“There must be appropriate systems and controls around valuations,” he said.

The remarks come amid the FSA’s high-profile efforts to improve how it monitors the fast-growing hedge fund industry in the UK. It also comes as hedge funds increasingly branch out into investments that are less liquid and more difficult to value. According to an Alternative Investment Management Associations survey, at the end of 2004 20 per cent of the assets held by hedge funds were hard-to-value securities.

The focus on valuation concerns also comes after instances of fraud at a handful of small US hedge funds, which cast a spotlight on valuation as a potential mine field for problems. Mr Waters said the record of US hedge funds had been “mixed”. Poor or fraudulent valuation procedures have resulted in the failures of US funds totalling an estimated $1.6bn.

So far, there have been no instances of valuation problems at hedge funds based in the UK. Mr Waters said he expected to find more robust processes in the UK, where funds are not self-administered. Nonetheless, Mr Waters said the FSA was working closely with the Securities Exchange Commission in the US. He noted that between them the two authorities regulated 85 per cent of hedge fund managers.

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