Rating agencies to abide by tougher industry code

BRUSSELS (Reuters) - Credit rating agencies will be banned from helping to design products they also grade as part of a tougher industry code of conduct to tackle issues raised by the U.S. subprime mortgage crisis.

A 2003 voluntary code drawn up by the International Organisation of Securities Commissions (IOSCO) is being beefed up at a meeting in Paris this week.

IOSCO will publish the new code later this week but it will stop short of calling for mandatory rules.

"The code will always be a voluntary code. It will be left up to individual member countries to decide if they want to bring in legislation," a source with knowledge of the meeting said.

The agencies include Standard & Poor's, a unit of McGraw Hill Cos. Inc, Moody's and Fitch, part of Fimalac.

IOSCO declined to comment ahead of publication.

Some policymakers say the sector is too lightly regulated and was slow to warn investors about risks from complex structured financial products tied to the U.S. home loans.

Agencies gave such products high ratings but their value tumbled amid defaults in the underlying home loans, triggering a global credit crunch that is crimping economic growth and forcing banks to write off over $200 billion from their holdings in structured products.

Agencies are also seen as having internal conflicts of interest as they are paid by the companies whose debt or products they rate and even help design.

Agencies give opinions or ratings on the chances of default on a company's bonds or financial products.

Investors use these ratings to help decide which stocks or financial products to buy. Ratings also have a major influence over how much capital banks must set aside to cover risk on their books.

Changes set to be added to the code include:

-- disclosure of the assumptions underlying the individual ratings for structured finance transactions;

-- prohibition of advice on the design of structured products which an agency also rates;

-- reasonable steps being taken to use information of sufficient quality to support a credible rating;

The agencies have already unveiled plans for internal changes to tackle the criticisms raised by the subprime crisis.

IOSCO members which comprise national market watchdogs from over 100 countries, including the United States, Japan and the European Union, agree to enforce guidelines they adopt.

The Securities and Exchange Commission is due to say in June what changes it wants to introduce in the United States.

European Union Internal Market Commissioner, Charlie McCreevy, the 27-nation bloc's top financial regulator, will come forward with his own proposals in coming weeks.

EU national market watchdogs have recommended creating a new "name and shame" oversight body to enforce IOSCO's beefed up code but McCreevy has said this was inadequate.

(Reporting by Huw Jones, editing by David Cowell)