Feb. 6 (Bloomberg) -- Moody's Investors Service and Standard & Poor's may be restricted from advising banks on structured debt securities after criticism the firms failed to downgrade subprime-related notes as investor losses mounted.

Ratings firms may face a code of conduct prohibiting ``advice on the design of structured products which an agency also rates,'' the International Organization of Securities Commissions in Madrid said today. IOSCO, the forum of securities regulators, also called on financial institutions to disclose their risk of losses from structured finance.

Regulators including Michel Prada, France's chief securities official and chairman of IOSCO's Technical Committee, have rebuked ratings companies for being involved in creating the securities responsible for at least $146 billion of losses in the wake of the subprime slump.

``This doesn't address the core issue, which is ratings being paid for by issuers,'' said Christian Stracke, a strategist at CreditSights Inc. in London. ``It's a good first step but it leaves a lot of wiggle room.''

Borrowers pay for credit ratings rather than investors. Potential conflicts of interest between rating companies and the banks that pay their fees were flagged last year by European Central Bank President Jean-Claude Trichet and U.S. Senate Banking Committee Chairman Christopher Dodd. The Securities and Exchange Commission said in August it was examining the way the companies assign ratings.

Ratings Response

Prada, France's securities regulator since 2003, focused on possible conflicts between ratings companies and investment banks that create collateralized debt obligations. ``The first depends more and more on the second in their business development,'' he said in September.

New York-based Moody's, S&P and Fitch Ratings are the three biggest debt ranking companies.

``S&P's ratings business doesn't provide consulting services and our analysts do not provide consulting services,'' said Martin Winn, a spokesman at the company in London. ``Together with the other rating agencies, we are proposing changes to the code that would explicitly prohibit ratings firms from carrying out these activities.''

Frederic Drevon, head of Moody's for Europe, Middle East and Africa, said the company supported the efforts of regulators. ``We look forward to sharing our views and participating in IOSCO's request for comment,'' he said.

Structured Fees

Moody's earned $884 million in 2006, or 43 percent of total revenue, from rating so-called structured notes, securities that package asset- and mortgage-backed debt, according to Neil Godsey, an equity analyst at Friedman, Billings, Ramsey Group Inc. in Arlington, Virginia. That's more than triple the $274 million generated in 2001.

CDOs are created by packaging assets including bonds, loans or credit-default swaps and using their income to pay investors. The securities are divided into different portions of varying risk, offering a range of returns.

``We are looking forward to reviewing the upcoming report and to continue working closely with IOSCO,'' said Richard Hunter, regional credit officer at Fitch in London.

SEC spokesman John Nester in Washington declined to comment today on IOSCO's statement.

`Key Players'

At the American Securitization Forum's conference in Las Vegas yesterday, Michael A. Macchiaroli, an associate director at the SEC, said ratings companies were among the ``key players'' that created the debt-market turmoil.

``They have to do some due diligence about whether what's going into these packages is of the quality that the asset originator says it is, and they have to divorce themselves from certain functions,'' he said during a panel discussion. ``The SEC does have some authority in this area, but there's been no particular discussions about what should happen.''

Ratings companies also may be required to take certain steps to ensure ``a credible rating,'' IOSCO said. While the group doesn't impose rules, its members are the main securities authorities in more than 100 countries from the U.S. to Japan.

IOSCO's Technical Committee set up a ``Subprime Crisis Task Force'' in November and proposals will be published in May. The committee is addressing the ``current market turmoil,'' the statement said.

Financial institutions should make ``accurate and complete disclosure'' of their holdings of structured products, IOSCO said in the statement. Investors should ``develop and undertake strict due diligence processes'' before investing in such securities.

After $8.9 billion of CDO downgrades today, S&P said it's cut ratings or started reviews on $342 billion of the securities ``as a result of stress in the U.S. residential mortgage market.'' Investors won't get any money back on some debt originally rated AAA.

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net

Last Updated: February 6, 2008 15:47 EST