Embattled credit-rating agencies like Moody's Corp and Standard & Poor's could catch a break on Tuesday when U.S. lawmakers sit down to craft a final rewrite of financial regulations.

The legislation as it stands would effectively upend the entire industry's business model, but lawmakers from the Senate and the House of Representatives could strip that provision as they begin resolving differences between their two Wall Street reform bills.

Democrats in charge of the process say there are relatively few differences between their two bills, which both aim to avoid a repeat of the financial crisis that plunged the world economy into a deep recession and led to massive taxpayer bailouts of Wall Street firms.

They plan to postpone the most contentious issues, such as how to regulate derivatives, until the end of the two-week process they began Thursday with opening statements.

Still, they will face billion-dollar decisions when they meet at 11 a.m. (1500 GMT) for their first full day of work.

The credit-rating industry has been widely criticized for assigning rosy ratings to dubious debt offerings that imploded and brought Wall Street to its knees during the 2007-2009 financial crisis. The Senate's bill, passed last month, would set up a new government panel to eliminate perceived conflicts of interest.

But Representative Barney Frank, who heads the House-Senate conference committee, is instead pressing for a one-year study of the issue by the Securities and Exchange Commission.

That would allow credit raters to continue soliciting business directly from the companies, municipalities and other issuers whose offerings they assess.

A spokeswoman for Democratic Senator Al Franken, sponsor of the original proposal, called Frank's counter-proposal very concerning.

Frank also aims to exempt smaller hedge funds and other private funds from registering with the SEC. The Senate bill, which is being used as a starting point for negotiations, would require firms that manage more than $100 million in assets to register; House Democrats hope to raise that to $150 million.

The agenda highlighted a surprising dynamic that has emerged over the past year of legislating: House Democrats, usually viewed as more liberal than their Senate counterparts, may in fact be Wall Street's best bet for softening legislation that is sure to crimp industry profits for years to come.

Republicans have largely opposed the reform effort and are not expected to play a significant role in final negotiations.

Frank and his counterpart in the Senate, Democrat Christopher Dodd, have pledged to conduct the committee's business in the open as they try to craft a final product for President Barack Obama to sign into law by July 4.

BEHIND-THE-SCENES WORK ON DERIVATIVES

Behind the scenes, negotiations continued as Democrats sought to resolve their most divisive issue -- how to regulate the $650 trillion derivatives market that led to the downfall of titans like insurer AIG during the crisis.

Banks looked increasingly likely to face some limits on swap trading as a proposal to rein in risky business practices gained traction.

Democratic Senator Blanche Lincoln revised her controversial proposal to allow banks to keep parts of their lucrative over-the-counter derivatives operations in a bid to mollify critics who had opposed a wide ban.

The fresh proposal would require the Wall Street giants that dominate the swaps market to spin off their dealing operations to a separately capitalized affiliate, but allow them to continue to use swaps to hedge their own lending activities.

That would protect banks' deposits, which are insured by the federal government, but allow the parent company to reap billions of dollars by trading swaps for clients.

Lincoln's provision has become a central target for Wall Street lobbying efforts and banking regulators during the final stages of resolving legislation that stretches to 2,000 pages.

Many Democrats have expressed doubt over her approach, arguing that taxpayers and bank customers could be better protected by limiting banks' ability to engage in speculative trading.

Later this week, the panel is expected to finalize rules that spell out how regulators can dismantle troubled firms before they threaten the entire financial system, an attempt to avoid the ad hoc approach government officials took during the crisis.

The House bill would raise $150 billion from the industry to cover the costs of unwinding troubled firms, while the Senate bill would cover the costs by selling off the troubled firm's assets and assessing fees on other firms in case of a shortfall.

The most contentious issues -- derivatives, consumer-protection measures and processing fees for debit cards -- will come up next week, according to a schedule released late on Monday.

(Additional reporting by Charles Abbott, Rachelle Younglai and Roberta Rampton; Editing by Andrea Ricci)

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