By Reuters | Tuesday, May 01, 2007 TOKYO (Reuters)âJapan's Financial Services Agency said on Tuesday [May 1] it will begin monitoring hedge fund managers operating in Japan, seeking to ward off potential turmoil in financial markets. The regulator will ask hedge funds to report their name and assets under management on an annual basis starting in September. The move applies to fund managers living in Japan and not to the majority of managers who live offshore. "We basically want to understand who are the main funds operating in Japan," said Mitsuhiro Kawamoto, deputy director of the securities business division of the FSA's Supervisory Bureau. The FSA may use the information to conduct further research. The regulatory framework for all funds is shifting with the implementation of the Financial Instruments and Exchange Law (FIEL), which replaces the Securities and Exchange Law. Changes made by FIEL on asset management are expected to come into effect in September after a period of public consultation. The objectives include enhancing disclosure requirements and user protection. "We welcome a variety of financial players as it helps activate Japan's financial markets," said Mr. Kawamoto. "But we have no intention of competing with Singapore and Hong Kong in lowering regulation since protecting investors is an important issue." Some industry experts questioned the effectiveness of the FSA's plans to gather more information on the hedge fund industry. "This is a storm in a teacup," said a Tokyo-based lawyer who works with hedge funds. "If the FSA excludes hedge fund managers based abroad it excludes 90% of the active funds from its inquiry." The FSA's powers of enforcement are also limited if the manager is based abroad and if the hedge fund only sells products to a limited number of professional investors. Poor Performers Hedge funds investing in Japan, which have about $36 billion under management, have been performing poorly of late because of a slide in small companies' share prices. Most hedge funds in Japan follow a similar strategy, buying small-cap stocks and shorting more liquid larger-cap shares, so when prices move against them they may sell and at the same time exacerbate falls in prices. Tokyo's Mothers' market for start-ups has fallen 16.4% this year and lost 56% in 2006. Singapore-based research firm Eurekahedge's index of Japanese hedge funds was down 3.4% in 2006 and is up just 1.3% in 2007. The fact that hedge funds are adopting similar strategies has also worried the Bank of Japan because it could represent a risk to the stability of financial markets. The central bank is concerned that if a large fund ran into trouble, as happened to Amaranth Advisors LLC when the U.S. fund lost $6 billion on energy trades last September, then a ripple effect could engulf other markets. The BOJ called repeatedly for more diversification of strategies last year. By Alison Tudor and Yuka Obayashi alison.tudor@reuters.com