UPDATE 4-Rating agencies to face EU legislation -McCreevy

(Adds S&P comments paragraphs 14, 15)

By Huw Jones

BRUSSELS, June 16 (Reuters) - Credit rating agencies will face mandatory new European Union regulation, EU Internal Market Commissioner Charlie McCreevy said on Monday, following criticism of their role in the U.S. subprime crisis.

The new rules would affect agencies including Moody's (MCO.N), Standard & Poor's (MHP.N) and Fitch (LBCP.PA), which dominate the hitherto lightly regulated sector.

McCreevy said in a speech, prepared for delivery in Dublin and made available in Brussels, that self-regulation had proved insufficient, calling their voluntary code of conduct "a toothless wonder".

The International Organisation of Securities Commissions, made up of national market watchdogs from the EU, United States and elsewhere, drew up the code and has just beefed it up.

But McCreevy said mandatory rules were needed, dismissing the view of IOSCO and EU national market watchdogs that a voluntary approach was still best.

"I am convinced meaningful but targeted regulatory measures are now necessary for rating agencies operating in the structured credit markets in Europe, including registration, external oversight and much better internal governance," he said.

Tougher oversight of credit rating agencies is seen as necessary by EU lawmakers to help avoid a repeat of the financial market turmoil that began last August with defaults in U.S. home loans and triggered a global credit squeeze.

Structured products backed by mortgages were highly rated by agencies but quickly sank in value and became untradeable, forcing banks to write down billions of dollars.

"ROT AT THE HEART"

"The fact is that despite the checks on compliance with the IOSCO code, no supervisor appears to have got as much as a sniff of the rot at the heart of the structured finance rating process before it all blew up," McCreevy said.

Measures announced by the rating agencies themselves were also insufficient, McCreevy added.

Registration of credit rating agencies was introduced in the United States last year, bringing them under direct supervision of the Securities and Exchange Commission market regulator.

A Moody's spokesman said on Monday: "Our Code of Conduct reflects our commitment to implementing guidelines established by both international and national regulatory organizations.

"Moody's will continue to be responsive to authorities, including the European Commission, as they consider oversight of our industry, either through legislation or voluntary measures," the spokesman added.

A Standard & Poor's spokesman also commented, "We are committed to continuing working together with market participants and policymakers to find solutions that support the effective functioning of global capital markets."

The agency believes "the global market is best served by a consistent international approach by regulators to this issue", he added.

Allen Blewitt, chief executive of the Association of Chartered Certified Accountants, said that rating agencies "have for too long had the luxury of not having to adhere to good governance and oversight procedures."

France takes over the EU presidency next month, and French Economy Minister Christine Lagarde has said she will start a debate among EU finance ministers on whether registration should be introduced in the 27-nation bloc.

Agencies also face tougher regulation in the United States, where the authorities want them to use a separate system for rating structured products.

FIREWALLS NEEDED

McCreevy has sole right to initiate EU financial services rules but EU states and the European Parliament have final say on their shape and adoption.

The ratings are widely used to help determine how much capital a bank must set aside to cover risk on its books.

Many officials and analysts are concerned that agencies are paid by the companies whose creditworthiness they rate. Many U.S. mortgage-related structured products sank in value despite an initially high rating.

McCreevy said it was absolutely essential to have robust firewalls between those who drive forward earnings of agencies and those who manage the quality of ratings.

"Remuneration and incentive packages for analysts must also be geared to underpinning long-term confidence in the ratings they disseminate," McCreevy said.

With the emphasis on tougher external oversight and better internal governance of rating agencies, McCreevy said regulators should not be in the business of giving an opinion on individual rating content.

McCreevy said the new legislation would aim to bring new rating agencies into the market.

"I hope we can also craft these measures in a way that will encourage entry to the market by new players, working perhaps on a different business model," he said, adding the Commission would draft new measures in coming months.

A spokesman at Fitch said: "No comment at the moment until we have a chance to see the proposals and review them." (Reporting by Huw Jones and Marcin Grajewski; Additional reporting by Jane Baird; Editing by Louise Ireland and Tony Austin)