Private individuals should be able to invest in hedge funds, but only in "fund of funds" packages so they are not exposed to the individual strategy of any one hedge fund manager.
This verdict came yesterday from John Tiner, chief executive of the Financial Services Authority, speaking after the regulator's annual public meeting.
The FSA has been consulting widely about the role of hedge funds and how they should be regulated and concluded that private investors, as well as financial institutions should have access to investment vehicles that seek to make money when markets go down, as well as up.
"We concluded that hedge funds were increasingly a core component of the financial market and also important to market stability, efficiency and innovation," Mr Tiner told the meeting.
"We also recognised that London had emerged as the main location of choice for hedge fund managers out-side the US.
"Overly heavy-handed regulation could send these businesses offshore, while the underlying market activity remained on the London markets.
"But we did identify some significant risks in this sector and so designed a carefully tailored regulatory approach which we believe is proportionate to these risks and which appears to have been welcomed by both the hedge fund managers themselves and investors in their funds."
More generally, Mr Tiner noted that for the most part this has been it a good year for the financial community -although losses of $50 billion-plus from hurricane Katrina absorbed by insurers and re-insurers, must four years after the nine-eleven catastrophe had been a severe test of the resilience of the insurance industry.
Rising markets had strengthened the banks and enabled life companies to rebuild their solvency after three years of decline at the start of the decade. Ample liquidity enabled firms to look at a wide range of investment opportunities.
But Mr Tiner added "I would also raise a cautionary note that the historical problems we have had to deal with in bear markets have their genesis in strong markets.
"We have been alert to products where the downside risks which may crystallise in weakened economic conditions may not have been made clear to customers."
