Half a world away from the U.S. subprime market's woes, Australian investors are scrambling to uncover what is happening at homegrown hedge fund Basis Capital and Asia's bankers are bracing for credit markets to dry up.

Just as Wall Street firm Bear Stearns confessed two funds specializing in risky subprime loans had very little value, Basis Capital warned some of its investors could receive less than 50 cents to the dollar.

Basis Capital may be an isolated case in Asia, where hedge funds mostly focus on emerging market stocks, but market players warn the U.S. subprime crisis is expected to have a ripple effect.

Lenders of all sorts will require more collateral, there will be tighter requirements on lending, leverage ratios will come down, said Peter Douglas, head of Singapore-based hedge fund consultancy GFIA.

Emerging debt has held up well, but subprime woes could hurt structured credit markets, said Robert da Silva, Asia Pacific fixed income fund manager for Principal Global Investors in Sydney.

At the moment, it's not having a dramatic impact on traditional emerging market bonds. It's had more of an impact on Asian demand for structured credit, he said. Issuance of these products will struggle and it will be more difficult to do these deals than before.

The Basis Capital saga also spells trouble for its creditors, who might be left holding the bag. They include JPMorgan, Citigroup, Goldman Sachs, Bear Stearns and Deutsche Bank, according to media reports.

REDEMPTIONS SUSPENDED

The winner of AsiaHedge magazine's fund of the year award in 2005, Basis Capital securitizes non-conforming assets such as car loans and personal loans. The idea is to package these loans into collateralized debt obligations (CDOs) and then to split them up into groups with varying degrees of risk.

The first sign of trouble came in a July 11 note to clients, warning that ratings downgrades on U.S. subprime debt had led to indiscriminate mark-to-market pricing by dealers. That's financial market speak for securities losing their value overnight.

Its A$316 million ($275 million) Basis Yield Fund took a hit of nearly 14 percent in June, while its A$341 million Basis Aust-Rim Fund fell by 9 percent. Then on Monday, the company suspended withdrawals.

A mini panic followed. Basis Capital wiped figures on its funds from its website, ratings agency Standard & Poor's put its top five-star rating on the two funds on hold, and local media reported the fund was on the brink of collapse.

S&P has been unable to secure a meeting with the management of Basis Capital, and to date our phone conversations with the managers have not provided the level of insight we require, S&P fund analyst David Erdonmez said in a statement on Wednesday.

That same day, the hedge fund told its investors in a note that its flagship fund was in default on margin calls after financiers cut their valuations on its assets.

It appointed accountants Grant Thornton for an orderly sale of assets, but warned a fire sale would cut the value of the fund's units to less than half their level at end-May.

It's a pretty horrible experience, but we know the Basis Capital guys quite well, so whatever clean-up has to be done they will do it carefully, Douglas said.

Basis Capital was set up in 1999 by former County NatWest investment bankers Steve Howell and Stuart Fowler, who worked extensively in Singapore and Hong Kong.

ASIA FALLOUT

Japan's Nomura Holdings Inc. already has taken an earnings hit on losses at its U.S. mortgage business, but analysts downplayed the risk to Asia's $151 billion hedge fund industry.

Some 56 percent of 1,100 Asia Pacific-focused hedge funds in the database of research firm Eurekahedge use basic long/short equity strategies, a much higher percentage than in the United States and Europe.

If you add event-driven and multi-strategy managers, about three-quarters of Asia Pacific hedge fund managers have little or no direct exposure to debt markets, said Julius Wang, a managing director with Hong Kong-based Vision Investment Management, which runs portfolios of hedge funds for investors.

I don't know of anybody else that had problems related to the subprime mortgage issues here in Asia, he said. It's still a very predominantly equity culture out here, so there's not as many of these fixed-income strategies.

A broader fall-out could hurt everybody, though.

Even a simple long/short fund is exposed to funding cost and so there will be an impact if the wave of liquidity starts to ebb, cautioned GFIA's Douglas.

(Additional reporting by Saeed Azhar in Singapore and Jeffrey Hodgson in Hong Kong)

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