China's hedge fund industry has been thrown into disarray as managers rush to comply with stringent new rules, introduced overnight, that could see over half the industry shut down by August, fund managers and lawyers told Reuters.

Domestic and foreign hedge fund managers are scrambling to secure legal advice, hire qualified staff and launch new products in a bid to save their licenses after the regulator threatened last month to close down around 17,000 "phantom" fund managers as part of a broader government financial sector crackdown.

The new hedge fund rules aim to shrink a vast industry insiders describe as a "Wild East" rife with fraud.

But many in the industry say the measures are heavy-handed and rushed, threatening to suffocate much-needed domestic and foreign institutional investment as the country faces its slowest rate of growth in more than two decades.

"It is very difficult for the regulators to police such a vast landscape so now they're trying to shake this number out," said Effie Vasilopoulos, a partner at law firm Sidley Austin in Hong Kong.

"This is a sensible thing to do, but the risk is that in trying to recalibrate, the pendulum is swinging too far in the opposite direction."

Hedge funds have attracted increased scrutiny in China amid fears the country's relaxed registration-based licensing regime has allowed fraudsters and shadow-lenders to proliferate.

Private fund registrations more than doubled in 2015 to reach more than 25,000, according to data from the Asset Management Association of China (AMAC), a self-regulatory body that oversees private funds. Roughly two-thirds of these are "phantom" fund managers that have not launched a product, and may be using the registration for illegal fund-raising or lending, said AMAC.

While many "phantom" funds may have done nothing illegal, the AMAC license, a requirement for operating a hedge fund, has often been used as cover for fraudulent peer-to-peer lending platforms, industry insiders say. Some fraudsters also raise money upfront for a bogus fund that is never launched.

Raising The Bar