The Group of Seven nations and other major economies will conduct the first joint field test of coordinated measures aimed at minimizing panic and preventing a domino effect when megabanks and huge hedge funds collapse, a Japanese government source said Saturday.

If realized, the joint drill will be the first international attempt to establish a policy coordination framework to deal with the risk of cross-border economic crises.

The agreement was reached at a March 22-23 meeting in Washington of the Financial Stability Forum, which is made up of international financial institutions and the G7 nations — Britain, Canada, France, Germany, Italy, Japan and the United States, the source told Kyodo News.

Australia, Hong Kong, the Netherlands, Singapore and other major economies that took part in the forum’s fifth meeting will also participate in the exercise, the source said, noting Japan will take an active role.

The source said the participants agreed to fix details of the exercise by next spring in line with a proposal made at the meeting by William McDonough, U.S. Federal Reserve Bank of New York president, and other members.

The drill will involve central banks, government financial and monetary supervisory and regulatory authorities, as well as the International Monetary Fund, the Bank for International Settlements and other international financial bodies, the source said.

The agreement calls for testing of coordinated measures on the assumption that a crisis involving U.S. hedge funds or other significant entities occurs.

It envisions measures such as setting up a system to facilitate communications among participating members, supplying emergency funds to prevent contagious failures and coordinated disclosure methods when releasing information to the public, the source said.

Participants will also focus on the use of public funds to deal with collapsed financial institutions and prevent contagious crises.

By conducting the exercise, participants hope to increase confidence in the measures, allowing them to work together to swiftly and effectively minimize the impact and contagious confusion when failures actually occur.

The source said the Japanese Finance Ministry, the Financial Services Agency and the Bank of Japan have decided to contribute actively to the proposed drills, given the advent of the “Big Four era” in Japan through recent mergers of major banks.

The forum’s meeting was attended by Haruhiko Kuroda, vice finance minister for international affairs, BOJ Executive Director Masayuki Matsushima and Yoshio Okubo, FSA deputy commissioner for international affairs.

Last year, Dai-Ichi Kangyo Bank, Fuji Bank and the Industrial Bank of Japan led the integration move by forming Mizuho Holdings Inc.

The three other mega groups were established in April — Sumitomo Mitsui Banking Corp., Mitsubishi Tokyo Financial Group Inc. and UFJ Holdings Inc.

Sumitomo Mitsui involves Sumitomo Bank and Sakura Bank, Mitsubishi Tokyo integrates the Bank of Tokyo-Mitsubishi, Mitsubishi Trust & Banking Corp. and Nippon Trust Bank, and UFJ groups Sanwa Bank, Tokai Bank and Toyo Trust & Banking Co.

The forum, which held its first meeting in April 1999, was established under a proposal in February that year by German Bundesbank President Hans Tietmeyer during a gathering of G7 finance ministers and central bank chiefs.

Its initial objective was to prevent a recurrence of the 1997-1998 financial crisis, which hit East Asia particularly hard, and to make the international system less vulnerable by strengthening regulatory and supervisory measures on highly leveraged hedge funds, offshore markets and short-term capital flows. The near-collapse in 1998 of U.S.-based Long-Term Capital Management LP shed light on the hidden dangers of hedge fund operations involving large, unchecked cross-border capital flows.

Washington, long an advocate of a more laissez-faire approach, has eased its opposition to controls on hedge funds, while Europe, Japan and emerging economies have been strongly pressing for tougher regulations.

Most vocal among developing nations is Malaysia, where Prime Minister Mahathir Mohamad has repeatedly urged advanced nations to control hedge funds, blaming speculative short-term capital investments for causing the prolonged Asian financial crisis.

Hedge funds are largely unregulated investment vehicles that pool money from wealthy individuals and organizations and invest in high-risk, high-return securities around the world.

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