The Financial Stability Forum said that the global economy looks generally healthy, but it singled out several sources of concern when its members met in Paris today.

The FSF noted that the economic outlook remains broadly supportive of financial stability. “Financial firms have strong balance sheets, and financial systems seem to be adapting well to the ongoing removal of accommodation in monetary policy in many countries and to shifts in the balance of demand among the major economies,” it noted.

However, the group’s members pointed to several areas of concern with the potential to cause strains in financial systems. “These include the capacity of households in some countries to manage rising debt levels and possible adjustments in housing markets, the rapid pace of leveraged buyouts and debt-financed acquisitions, the growing complexity of financial instruments, and persistent global current account imbalances,” it says. “Financial market participants need to take account in their risk analysis and pricing of the full implications of a possible reversal of the current benign conditions, including less liquid markets.”

The FSF encouraged financial firms to further strengthen their risk management practices, in particular in running stress test scenarios involving low probability, high impact events or in which several vulnerabilities crystallise in combination.

Members also reviewed the infrastructure for over-the-counter derivatives, the growing role of hedge funds and counterparty risk management, it noted. They welcomed progress by financial firms in improving the trading and settlement infrastructure for credit derivatives, and in further strengthening counterparty risk management concerning complex products. However, they also noted that further work is needed to improve the infrastructure of these rapidly growing market segments, particularly in areas such as the automation of trade processing and settlement, and they encouraged the extension of these efforts to other types of OTC derivatives.

FSF members also stressed the importance of reliable valuation practices for illiquid products. “Concerning hedge funds, the Forum stressed the importance of financial firms maintaining appropriate margining practices and guarding against any weakening of credit standards in prime brokerage and other counterparty relationships. Hedge funds themselves should make further progress in strengthening risk management practices,” it said.

The Forum also talked with representatives of the Institute of International Finance on how regulation could be made more effective and efficient, and discussed ways to further enhance the dialogue between regulators and the financial industry.

The FSF discussed preparedness for an avian flu pandemic in financial authorities and the wider financial sector, including efforts to foster international communication and cooperation. It encouraged financial industry participants and authorities to make use of the Joint Forum’s high-level principles for business continuity, which were published in final form in August.

The group also discussed offshore financial centres. The FSF’s OFC Review Group is continuing to monitor progress by FSF member bodies in working with OFCs to improve cross-border cooperation and exchange of information, it noted. The FSF encouraged OFCs to continue to cooperate with IOSCO and to participate in the IMF’s ongoing assessment program in a timely fashion and to publish their IMF reports, including the detailed assessments.

FSF members reviewed recent international accounting and auditing developments, including the need to achieve more consistent interpretations of International Financial Reporting Standards. They welcomed work on convergence and harmonisation underway between the IASB, the US FASB and other authorities.

“Members expressed concern about recent incidents that raised questions about the quality controls in place within global accounting firms and the concentration of audit services for large companies at the four largest audit firms,” it said. “Members agreed to promote higher audit quality, given its importance for regulatory efforts. The FSF welcomed the proposal to create an International Forum of Independent Audit Regulators that could enhance and bring more global consistency to audit oversight and audit quality.”

The next meeting of the Financial Stability Forum will be held in Frankfurt on March 29 2007. Today’s meeting was the first meeting chaired by Mario Draghi, Governor of the Bank of Italy.