A top-level body of financial experts set up to monitor issues of global market stability, warned this week investors' appetite for risk is declining, and said the shift could bring new market turbulence.
Following a closed-door meeting in Frankfurt on Thursday, the Financial Stability Forum said that the turbulence in equity and credit markets in late February and early March could augur much deeper and prolonged turmoil in future as investors reduce their willingness to take risk.
The recent turbulence "involved an adjustment in risk positions amidst some increase in macroeconomic uncertainty and concern about the scope of problems in the US subprime mortgage sector," FSF said in a statement.
"Market participants need to ensure that risk management scenarios take appropriate account of the risks and potential consequences that would arise from a more pronounced and prolonged reduction of risk-taking," the body cautioned.
The FSF was set up in 1999 by G7 (Group of Seven) finance ministers and central bank governors to promote international financial stability and brings together senior representatives from international financial institutions, regulatory groups and the national financial authorities of the world's major economies.
The body said that market participants should also pay attention to risks related to the rapid growth of hedge funds, highly speculative and aggressive investment instruments that are estimated to manage 1.4 trillion dollars (1.1 trillion euros) in assets worldwide.
"Hedge funds have significantly expanded their involvement in credit markets, where complex products can pose substantial risk management and valuation challenges," FSF said.
Germany has long campaigned for increased transparency and even regulation of the largely uncontrolled sector and has placed the issue at the top of the agenda during its year-long presidency of the G8 (Group of Eight) this year.
FSF said that at the meeting its members "emphasised the importance of enhancing the effectiveness of market discipline and continuing attention to strengthening counterparty risk management practices."
The FSF is in the process of preparing an update of its 2000 report on Highly Leveraged Institutions which it is due to present to G7 finance ministers in May.
The forum said it is also monitoring the rapid growth of company buy-outs supported by private equity funds.
"Members believe that the private equity market plays an important role in efficient capital allocation. At the same time, it was agreed that the FSF should continue to monitor developments in this area, particularly as they relate to overall corporate leverage, the credit exposures of intermediaries and potential implications for financial stability," it said.
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