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 amid outbreaks of violence there.
The British and Pakistani 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 guns in the streets and setting fire to any shops which remained open.
Another, Nabil, said there had been "turmoil" and "massive confusion" about whether Altaf Hussain had been arrested or not.
Karachi in fear after Altaf Hussain arrest
Pakistan's powerful but absent politician
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 costs".
"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.
Police later confimed that Mr Hussain had been escorted to a hospital appointment while still in custody.
For many years now, Altaf Hussain's MQM has had a bloc of about 20 members in the National Assembly, making him a powerful figure both in Pakistan's biggest city Karachi and in the country as a whole. Remarkably he has led the party from London for over 20 years for fear that going back home could result in legal cases or a physical threat to his security.
As well as his solid electoral base in Karachi, Mr Hussain has a powerful party organisation in the city which is often accused of extorting money from businesses and using violence - or the threat of it - to get its way.
For years the British authorities tolerated the MQM being based in London. In fact British diplomats sought to take advantage of the situation by trying to influence the party to help achieve British objectives in Pakistan. But the mood changed when a senior MQM party member Imran Farooq was murdered in London in 2010.
Mr Hussain, his party, and some of his associates and relatives are currently the subject of a number of British investigations.
One is looking into the question of whether in his televised speeches he has incited violence in Pakistan, charges Mr Hussain denies. Another is into whether the MQM has paid its UK taxes correctly.
The most high-profile investigation followed the 2010 murder in London of a senior MQM leader Imran Farooq. No-one has been formally charged with his killing.
The MQM is often accused of extorting money from businesses in Karachi and shipping the money to the UK, charges the party also denies.
Police in London have arrested the leader of Pakistan's powerful MQM party, Altaf Hussain, on suspicion of money-laundering.