The secretive world of hedge funds faced greater scrutiny today after the City watchdog paved the way for regulation of shadow banking in some cases.

Lord Turner said hedge funds that had become as important to the stability of the financial system as banks should be regulated along the same lines.

He said the FSA should probe the work of hedge fund managers in London even if the funds themselves were based offshore. It could then insist on higher levels of capital or impose other restrictions “if any institution or group of institutions develops bank-like features that threaten financial stability”.

The proposals were broadly welcomed.

“It appears that many hedge-fund managers will not be subject to profound changes,” said Tim Dolan, a partner at law firm Pinsent Masons. “The review concludes many hedge funds do not behave like banks and have lower leverage than banks and should not therefore be treated in the same manner as banks.”

Turner also called for greater regulation of credit-rating agencies.

“Poor credit ratings and poor use of credit ratings played an important role in the crisis,” he said. “We must regulate credit-rating agencies to ensure rigorous analytical independence and ensure they only rate instruments simple enough, and with enough historic record, to make rating possible.”