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BRUSSELS (Reuters) - A European Union watchdog said it was investigating credit rating agencies to look at how they rank sovereign bonds and other debt and could impose heavy sanctions if it finds any wrongdoing by the influential institutions.
Officials from the European Securities and Markets Authority have been visiting offices of the three big agencies -- Standard & Poor's, Moody's and Fitch -- as well as smaller rivals, since the start of last month and will continue to do so throughout December.
The exercise takes on increased significance after Standard & Poor's said on Monday it may downgrade the ratings of 15 euro zone countries, an unprecedented move that rattled markets ahead of a summit of EU leaders to tackle the debt crisis.
Some euro zone officials say the ratings agencies have worsened the crisis. European Central Bank governing council member Christian Noyer said that S&P's methodology had become more political and less connected to economic fundamentals.
"We will publish a report on the outcome of our first on-site inspections of ratings agencies," the ESMA spokesman said on Tuesday, adding that this would come at the latest in April.
"Our inspectors are examining how the rating agencies conduct their business and arrive at ratings. If we were to find wrongdoing, ESMA has the power to fine agencies, suspend their ratings and we could even withdraw their license."
The Paris-based watchdog was set up this year to be the chief European supervisor for ratings agencies and its audit marks the first strong policing of an industry that until now could not be challenged on its decisions.
"We don't comment on our confidential interaction with regulators," said a spokesman for Standard & Poor's.
To carry out their audit, regulators can ask for documentation outlining how an agency arrived at the decision to downgrade a country, for example.
Although ESMA is not able to question specific decisions like a credit downgrade, it could penalize a rating agency if it were to find flaws in the way it works.
"They have to prove they have a sound rating procedure such as avoiding conflicts of interest, as well as having proper internal rules," the ESMA spokesman said.
"We are not watching every single rating decision. ESMA's job is to ensure raters comply with the rules."
Reporting By John O'Donnell; additional reporting by Huw Jones in London; editing by Anna Willard