The draft law, due to be made public Wednesday, comes after ratings agencies were entangled in the U.S. subprime meltdown. EU policy makers said ratings agencies, which analyze risks facing companies and bond issuers and evaluate financial instruments, failed to spot bad loans lurking on banks’ balance sheets, fueling the current credit crisis.

The “sometimes poor quality of ratings of structured finance instruments has considerably contributed to the current crisis,” the EU’s draft legislation said.

To prevent further lapses, the EU wants credit-ratings agencies to register with the Committee of European Securities Regulators and abide by a series of new rules. Ratings companies until now have followed a voluntary code of conduct in the EU, which the bloc’s chief markets regulator, Charlie McCreevy, called a “toothless wonder.”

In the U.S., ratings agencies such as Standard & Poor’s Corp., a unit of McGraw-Hill Cos., Moody’s Corp. and Fitch Ratings, a unit of Fimalac SA, have been registered since last year and have had to follow U.S. Securities and Exchange Commission rules.

In addition to registration, the EU’s planned law will require agencies to “disclose the methodologies, models and key assumptions they use in the rating process,” the draft said. An annual report detailing the success rate of agencies’ ratings also must be published.

Ratings agencies will have to ensure there are no conflicts of interest in their work. The planned EU legislation will ban agencies from providing consulting or advisory services and require them to disclose their 20 largest clients by revenue.

Agency employees also will have to rotate the areas they cover on a regular basis to ensure their independence isn’t compromised. These employees also will have to have “appropriate knowledge and experience” to issue ratings, the EU proposal says.

The EU wants each of its 27 member countries to designate an authority to enforce its new rules. These overseers will coordinate their work through CESR and will have full powers to probe ratings agencies’ work. They can conduct surprise inspections, demand documents, summon employees for questioning and review telephone and e-mail records, according to the draft EU law.

These national authorities will impose penalties on ratings agencies that break the law. The EU legislation doesn’t say detail possible punishments, but said they should be “effective, proportionate and dissuasive.”

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