WASHINGTON (Reuters)—U.S. lawmakers on Tuesday girded for a showdown over a measure that could upend the business model of credit rating agencies like Standard & Poor's Corp. and Moody's Corp. in the first real test of the congressional panel crafting a final Wall Street reform bill.

Negotiators from the House of Representatives moved to strip out a measure designed to eliminate perceived conflicts of interest in the industry, setting up a confrontation with their counterparts in the Senate who have backed the provisions.

The two sides planned to work out their differences later in the day. The House-Senate panel aims to send a final bill to President Barack Obama to sign into law by early July.

The credit-rating industry has been widely criticized for assigning overly rosy ratings to dubious debt offerings that imploded and brought Wall Street to its knees during the 2007-2009 financial crisis. Lawmakers said the need to drum up business from the companies whose debt the agencies rate gave them an incentive to sweeten their ratings.

"We shouldn't be surprised what happens when we have the umpire selected by the home team," said Rep. Brad Sherman, D-Calif.

The two sweeping bills the House and Senate negotiators are trying to reconcile aim to avoid a repeat of the crisis that plunged the world economy into a deep recession and led to massive taxpayer bailouts of Wall Street firms.

Lawmakers plan to postpone the most contentious issues of until the end of the process, which they hope to wrap up on June 24.

Even as the ratings agency issue dominated the public agenda, Democrats were privately approaching consensus on one of the most contentious aspects of the bill, a proposal to curb risky trading by banks.

Action on that measure, however, was still days away as the panel focused on the fate of the ratings agencies.

Holding raters to account

The Senate's bill, passed last month, would set up a new government panel that would assign new structured debt offerings to ratings agencies on a semi-random basis.

House negotiators unanimously voted to strip that out and replace it with a one-year study by the U.S. Securities and Exchange Commission.

Rep. Barney Frank, D-Mass., who heads the conference committee, said the House version would hold the industry accountable by making it easier to sue agencies that issue misleading ratings and removing the requirement that government agencies use their ratings as they go about their work.

"We did the best we could to put people on notice that they ought to be doing their own diligence," Rep. Frank said.

Credit ratings agencies already are likely to see their business costs rise as they deal with higher transparency and reporting standards, said Edward Atorino, analyst at The Benchmark Company in New York.

The move 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.

Rep. 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.

On Wednesday, Rep. Frank wants to remove a Senate-approved measure that would make the head of the New York Federal Reserve Bank a political appointee, rather than one appointed by industry.

House Democrats also aim to require investment brokers to adhere to a higher client-care standard, to roughly the level now followed by investment advisers, according to a document released on Tuesday.

Behind-the-scenes work on derivatives

Behind the scenes, 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 American International Group Inc. during the crisis.

Banks looked increasingly likely to face some limits on swap trading after Senate Agriculture Committee Chairman Blanche Lincoln, D-Ark., softened a proposal that would require banks to spin off their lucrative swaps dealing desks.

Her new plan would require the Wall Street giants that dominate the swaps market to spin off their dealing operations to a separately capitalized affiliate, but it would let them continue to use swaps to hedge their own lending activities.

Shelia Bair, the chairwoman of the Federal Deposit Insurance Corp., who had criticized Sen. Lincoln's original plan, told Reuters Insider she was "encouraged" by the new proposal.

Rep. Collin Peterson, D-Minn., the House Agriculture Committee chairman, told Reuters he would "probably be comfortable" with it and predicted it would become law in some form.

The 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.