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The FSA has stopped short of directly regulating the hedge fund and private equity industries, according to the regulator.

At the economic and monetary affairs committee public hearing, Dan Walters, director of retail policy and themes and sector leader for the FSA, said hedge funds themselves were outside of the FSA's jurisdiction, but that hedge fund managers - of which there are 450 in the UK collectively managing 80 per cent of Europe's Euros290bn- did fall within the regulator's remit.

However, Mr Walters avoided making promises, saying the FSA's approach to hedge funds did not extend to "prescribing or second-guessing their [hedge fund managers'] strategies, or preventing those who invest in them from losing money."

He said the onus was on investors to make prudent decisions with their money. He said: "We expect investors of this nature to exercise a substantial degree of responsibility for their investment decisions and to bear the risks of high rewards and significant losses that can occur."

Reacting to comments made in the working paper on the same subject, Mr Walters said: "We do not agree with the working paper's assertion that hedge funds 'operate in the shadows' and that they use 'investment strategies, trading techniques and financial instruments that remain largely unregulated'. Most hedge funds make use of the same financial instruments as other asset managers, investment banks and other institutional investors."

However, Chris Erwin, investment principle for Aon, said transparency was lacking in the industry. He said: "We would say that the hedge fund sector is relatively un-transparent – it is more difficult to find out what is going on with hedge funds than it is with other investments."

Explaining the reasons, he pointed to a number of contributing factors. He said: "The universe in which they invest is infinite. It is not like you are investing in an equity fund where there is a limited equity universe, rather your hedge fund can be in commodities today and statistical arbitrage tomorrow. The second thing is they gear up and the final thing is that you cannot assess risk in hedge funds by normal analysis."

Commenting on the role of the FSA, he said they were side-stepping, but recognised the difficulty in direct regulation. He said: "The FSA is walking away, but on the other hand it would be virtually impossible to regulated properly."