The former Wales and Manchester United striker, 46, succeeded Roy Hodgson, who moved to Liverpool earlier this month.
"I am happy to have joined Fulham following much speculation regarding the appointment of a new manager," Hughes told the Fulham website.
Fulham owner Mohamed Al Fayed moved for Hughes after missing out on Dutchman Martin Jol, whose club Ajax Amsterdam refused to let him leave.
Hughes, who had a glittering playing career which included a spell at Fulham's west London neighbours Chelsea, began his managerial career with Wales in 1999 and managed Blackburn Rovers before taking over at City in 2008.
Fulham enjoyed one of their best seasons in 2009-10 - finishing 12th in the Premier League and reaching the Europa League final, losing 2-1 to Atletico Madrid after extra time.
Hughes has a tough act to follow at Fulham, where Hodgson made the most of the club's resources and took them to their first ever European final.
"I'm joining on the back of two of the most successful seasons in the club's history, and that in itself brings with it the challenges of expectation and ambition," said Hughes.
"I'm confident that with some additions to the squad, hard work and commitment, we can move this club forward in the right direction," he added.
BUILD ON SUCCESS
Chairman Al Fayed was convinced Hughes could build on the club's success after Hodgson took them on an unexpectedly rewarding European adventure during which they beat Juventus.
"I am confident that with his Premier League and national team successes, Mark will be a great guy for the job," he said. "I know that he understands my vision for the club and believes in what we want achieve."
Hughes will take charge of the team for the first time in the friendly with Werder Bremen on August 7 after being officially unveiled at a news conference next Tuesday. Fulham open the new Premier League season with a visit to Bolton Wanderers the following weekend.
As a player Hughes won two Premier League titles with Manchester United and four FA Cups with both United and Chelsea.
He also played for Barcelona and Bayern Munich and moved into management as Wales boss after his playing career ended, narrowly failing to take them to the Euro 2004 finals in Portugal.
Four years at Blackburn Rovers included him taking them to their first FA Cup semi-final for 40 years before he moved on to Manchester City.
After the Abu Dhabi United Group took control of the club in 2008, Hughes was empowered to spend millions on players, but he was not given time to build a title-winning team there and was replaced by Roberto Mancini last December.
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