Wall Street's second-largest investment bank is essentially tying its promise to provide financing to hedge fund clients to the prices of credit insurance on its own debt. If the cost of the protection rises to a certain level, that would trigger a reduction in Morgan Stanley's commitments to hedge funds, the report said.

The message is that "if our firm is in trouble, we would rather fund ourselves than fund you ," the paper quoted a brokerage executive with knowledge of the arrangements.

Morgan Stanley did not immediately return a call seeking comment.

Last week, Morgan Stanley and JPMorgan Chase & Co agreed to buy back billions of dollars of illiquid auction-rate securities and pay fines to settle charges that they misled investors about the debt's risk.

The investment bank had agreed to buy back $4.5 billion of debt and pay a $35 million fine to settle the charges.

In June, it reported a 57 percent drop in quarterly earnings on weak trading, investment losses and a slowdown in investment banking, even after it realized $1.43 billion in one-time gains.

(Reporting by Saumyadeb Chakrabarty in Bangalore; Editing by Kim Coghill)