Officers are searching a residential address in north-west London where they say a 60-year-old man was detained.
Mr Hussain has lived in the UK since 1991, saying his life would be at risk if he returned to Pakistan.
His party, which controls Karachi, has urged supporters to stay calm. Police are on alert amid reports of violence.
The British and Pakistan authorities have in the past expressed concerns that any arrest of Altaf Hussain could lead to violent protests in Karachi.
Shootings have been reported from some parts of Pakistan's largest city, which BBC correspondents say is tense.
Traffic jams were reported in Karachi and other cities in Sindh province as businesses closed and people headed home fearing violence.
One man in the city, who gave his name as Tahir, told the BBC that MQM supporters were firing in the streets and setting fire to any shop which remained open.
Another, Nabil, said there had been "turmoil" and "massive confusion" about whether Altaf Hussain had been arrested or not.
Who is Altaf Hussain?
Born in Karachi in 1953 to a middle-class family; studied pharmacy at university.
Formed MQM party in 1984 to represent Mohajirs - descendants of Urdu-speaking Muslims who migrated from India to Pakistan.
Requested political asylum in UK in 1992, later gained British citizenship; continues to run MQM from north London.
Karachi has been wracked by violence - much of it politically motivated.
Security is being tightened around the British mission in the city, which has been closed temporarily, and other buildings.
A Muttahida Qaumi Movement (MQM) spokesman in London, Nadeem Nusrat, confirmed the arrest and urged its supporters to "maintain peace at all cost".
"The police arrived with a search warrant and wanted to question Mr Hussain regarding allegations of money laundering," he said in a statement.
Mr Hussain had been "very unwell" for the past few days and was getting ready to go to hospital when the police arrived, the statement added.
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