Hedge funds, known for flexing their financial muscles around the globe but still largely shut out of China, hope the quickening pace of Beijing's reforms will open new gateways into the world's fourth-largest economy.

Chinese officials remain suspicious of overseas hedge funds, after witnessing the turmoil partly blamed on the likes of financier George Soros' Quantum Fund during the 1997/98 Asian financial crisis.

Unlike foreign banks, mutual funds and brokerages, hedge funds are excluded from forming fund management ventures in China, which Barclays Capital predicts will offer the highest growth potential of any asset management market in Asia over the next two years.

China, with $1.2 trillion in foreign exchange reserves and $2 trillion in personal savings, also bars domestic investors from buying into hedge funds, although it has let selected China-based financial firms invest in overseas capital markets.

That's why overseas hedge fund managers such as Andrew Smith and his colleagues were rushing around Shanghai last week meeting Chinese regulators to introduce themselves and the industry.

The main point is really to educate people about our marketplace and try to demystify a little bit the perception of hedge funds, said Smith, a partner in hedge fund Fairfield Greenwich Group, which manages about $15 billion.

Beijing shares the skepticism of many governments toward hedge funds, once derided by a German politician as locusts and periodically portrayed in China's local media as predators that only contribute to chaos in the financial markets.

But this has not kept hedge funds -- which have grown to $1.5 trillion worldwide and have an established presence in Hong Kong, Singapore, Japan and Australia -- entirely out of China.

Some hedge funds have entered the market by buying into the $30 billion quota for overseas investment banks under China's Qualified Foreign Institutional Investor (QFII) scheme, which lets foreign firms invest in domestic stocks.

They may be finding alternative entry routes, as well, with the Chinese Academy of Social Sciences, a top Chinese government think-thank, estimating that global hedge funds invested as much as US$50 billion into China's soaring stock markets, according to a report in the South China Morning Post last month.

BENEFITS OF REFORM

Hedge funds are very active in investing in China, driven by its economic growth, opening of the financial market and the renminbi appreciation, said Rex Chan, head of research at China Hedge, a hedge fund adviser in China.

Worried that foreign hot money from hedge funds and other investors may be inflating China's share prices and currency, Chinese regulators have pledged repeatedly to step up checks on cross-border flows of short-term capital.

But hedge funds, whose clients overseas include pension funds and other conservative investors, are seeking an accepted role in China's markets and inclusion in reforms that have benefited other foreign financial institutions.

China surprised the markets last month by agreeing to invest $3 billion of its foreign exchange reserves in U.S. private equity powerhouse Blackstone Group.

It has also recently allowed domestic institutions to invest clients' funds in overseas stocks, easing its previous limitation to fixed-income products.

China's development of financial derivatives markets has particularly excited hedge funds -- which make extensive use of derivatives to seek profits in both rising and falling markets.

Regulators are preparing to launch stock index futures trading and to expand the stock warrant market.

Given the Chinese stock market is relatively immature and irrational, hedge funds are likely to generate decent returns in 2007 if the index futures are launched, said Rob-Roy Roedel, chief executive of Zurich-based hedge fund Plenum Investment.

Roedel and top executives from several other hedge funds, including Netherlands-based Finles Capital Management, were also in Shanghai early this month to raise their profile.

Some hedge funds have set up offices in China to conduct research to facilitate investment in Chinese stocks.

Robin Lewis, head of Fairfield Greenwich Group's proposed Beijing representative office, said it appeared just a matter of time before Beijing lifts its ban on Chinese investment in hedge funds, given recent efforts to integrate further with the global capital markets.

Nobody has a timetable but nobody would disagree that every step in the reform process has happened more quickly than anyone anticipated all along the line, he said.

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