LONDON A central plank of European moves to rein in credit rating agencies was diluted by lawmakers on Tuesday, bowing to pressure from banks and companies who argued that proposals were unworkable or counterproductive.
An initial plan for ratings agencies to be rotated or switched every three years will be weakened to apply only to very specific types of credit and only every five years, the source said.
The pullback comes after Europe's biggest companies and banks warned that forcing them switch between so few global agencies could force them to use less well-known bodies carrying less credibility particularly with investors from the United States or Asia.
The proposed reforms come after the credit ratings sector, dominated by the "Big Three" of Standard & Poor's MHP.N, Moody's (MCO.N) and Fitch Ratings (LBCP.PA), was slammed for giving high ratings to securitised debt or ABS linked to U.S. home loans, leading to the market crisis of 2007 through 2009.
Policymakers worry ratings carry too much clout and have blamed the timing of Greek debt downgrades for making an EU bailout harder. The issue remains pertinent as Moody's is expected to downgrade some of the world's top banks this month.
"The debt crisis in the euro zone has shown that credit rating agencies have gained too much influence, to the point of being able to influence the political agenda," said Leonardo Domenici, an Italian centre left lawmaker.
A draft EU reform of the sector, the third in as many years, would have forced companies that use ratings to rotate or switch agency every three years to boost standards and competition.
The European Parliament's economic affairs committee voted in favour of diluting rotation, requiring it every five years and only for ratings of structured products (a category which includes ABSs), a far cry from the original plan.
A core aim of broad rotation was to boost competition in a sector lawmakers have described as an oligopoly.
The EU's competition chief Joaquin Almunia agreed on the need to improve competition but felt the best way was through regulation rather than using the bloc's antitrust powers.
"So far we have not received a single complaint on this and have not found enough arguments to open an investigation," Almunia told the lawmakers just ahead of their vote.
EU states, which have joint say over the shape of the final law, have already agreed an even bigger rowback to cover only a subset of structured products.
There would also be less reliance on "mechanistic" use of ratings for calculating bank capital buffers, forcing lenders to rely more on in-house models.
Yet the diluted reform is still opposed by some in the industry.
The Association for Financial Markets in Europe, a lobby group for the big banks, says mandatory rotation is excessive and could harm a revival of the securitisation market, which is needed to help banks fund themselves.
Meanwhile other reforms may proceed as planned.
Parliament voted in favour of giving investors the power to sue agencies that breach rules, using the civil law of the investor's country of residence when the damage occurred.
Parliament agreed on forcing agencies to restrict changes on sovereign debt ratings from the 27 EU countries to two or three fixed dates each year, notified in an annual timetable.
Regulators could agree to extra changes only if they agree there are exceptional circumstances, creating a rule that agency officials say would amount to censorship.
After the vote, negotiations between lawmakers and EU states start on a final text that will come into force later this year or in 2013.
EU countries are expected to challenge some of parliament's decisions, in particular reversing the burden of proof and any ban on use of non public information.
(Editing by David Cowell and David Holmes)