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The EU looks to crack down on ratings agencies.MIKE SEGAR/Reuters

The European Union unveiled plans on Tuesday to shake up credit rating agencies, although it shelved for now a divisive move for temporary "blackouts" on some sovereign ratings.

The bloc's financial services chief, Michel Barnier, said his draft law would inject competition in a sector dominated by three companies – Moody's, Standard & Poor's and Fitch Ratings – who warned the rules would leave investors with less choice.

After opposition from countries like Britain, Mr. Barnier withdrew a provision outlined in and earlier leak for temporary "blackouts" on ratings of countries when bailouts are being organized for them.

Many EU policy makers want tougher rules for the sector, saying a ratings downgrade of Greek sovereign debt last year made it more expensive to mount the country's first bailout.

"I proposed a postponement on this to go further into the technical detail," Mr. Barnier told a news conference.

He would now look at whether the European Securities and Markets Authority could still be given powers to intervene.

An EU official said the blackout plans were "still on the cards" though analysts welcomed Tuesday's rethink. "If the rating of a country would have been prohibited, it would have prompted market panic," said Karel Lannoo, a financial expert with think tank Centre for European Policy Studies.

"This idea was the weakest part of the proposal. But reason seems to have prevailed," Mr. Lannoo said.

Moody's said banning credit ratings would send a very clear signal to investors that regulators have intervened to limit information and would reduce investor confidence further.

The Association for Financial Markets in Europe, whose banking members are big users of ratings, was concerned that "any ability for ESMA to suspend sovereign ratings may damage the independence of the credit rating agencies."

The accidental downgrade last week by S&P of France's banking industry has also reinforced Mr. Barnier's determination to regulate agencies more closely.

S&P said the draft law is out of step with other regulatory regimes and will damage ratings as a globally consistent benchmark of creditworthiness. "It will leave investors worldwide with fewer, lower quality and less independent ratings on European debt," it said.

EU states and the European Parliament, which is meeting in Strasbourg this week, will have the final say on the measure, with some changes likely.

Leonardo Domenici, the centre-left EU lawmaker who will steer the measure through parliament, said the proposal disappointed after significant elements were ditched.

The European Union also gave the green light on Tuesday to curbs on trading of the sovereign-debt related derivatives that sit at the heart of the euro zone crisis.

The parliament on Tuesday voted by 507 to 25 in favour of an EU law that restricted naked, or uncovered, short selling of shares and sovereign debt – where the short seller has made no prior arrangements to borrow the security.

EU states have already given the nod to the law which also bans naked sovereign credit default swaps (CDS), where the swapper does not have ownership of the underlying government debt the CDS contract insures against default.

The new rules do allow purchases of naked sovereign CDS where the buyer owns a proxy, such as a stake in an Italian bank. An EU state can lift the ban for up to 18 months if its government debt market is not working properly because of it.

"This rule will make it impossible to buy CDS for the sole purpose of speculating on a country's default," French Green Party member Pascal Canfin said.

Hedge funds are accused of using sovereign CDS to bet on falling euro zone debt prices, but they say the market is too small to influence the much larger debt market and that the main problem is euro zone debt piles frightening investors.

The rating agency law seeks to inject more competition by requiring users of ratings, such as companies and banks, to "rotate" or switch agencies on a regular basis so that some of the 10 or so smaller agencies registered in Europe, such as Euler Hermes, can pick up more business.

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