Jay Garner, the retired US general in charge of Iraq, has told a meeting of local leaders that the country must have a democracy which represents all groups.
Some Shias feel they are not adequately represented
About 300 delegates, representing various religious, political and ethnic groups, are taking part in the conference to discuss the formation of an interim government for Iraq.
Among those attending the US-hosted meeting are members of the largest Shia group - the Supreme Council for the Islamic Revolution in Iraq (Sciri) - which boycotted earlier talks.
US helicopters, tanks and soldiers formed a tight security cordon around the conference hall, as several hundred Shias gathered in the centre of Baghdad to protest against the talks.
Monday's conference opened about two hours later than scheduled, and delegates were searched as they passed through the security cordon.
After a reading of the Koran, Mr Garner addressed the conference which he said was aimed at "a democratic government which represents all people, all religions, all tribes".
Iraqis, he said, should be given the tools they needed for the reconstruction of their country.
Mr Garner said the first priority was to restore order, adding that talks on security would be held in Baghdad on Tuesday.
Reporting from the meeting, the BBC's Claire Marshall said the biggest cheer came when Mr Garner pledged that Iraqi oil was for the Iraqi people.
Britain, the main US ally in the war, was represented at
the meeting by Foreign Office Minister Mike O'Brien.
In comments welcomed by Sciri, he told reporters that he envisaged a process that would include a referendum
on a new constitution.
Delegates at the meeting raised concerns about the lack of security, electricity and water.
But our correspondent says one influential Shia leader sounded an optimistic note.
Baghdad residents are still facing shortages
"The Iraqi people owe a lot to the United States and the United Kingdom... for deposing the dictator," said Sheikh Hussein Sadr, dean of the Islamic Council in London.
He added that Iraq could only be ruled by Iraqis.
General Garner has said before that he hopes the process of forming an Iraqi Government will start by the end of this week.
But he has cautioned that, before reconstruction can begin, there has to be security. Talks on the issue are to be held on Tuesday.
Those invited to Monday's conference include Iraqis - from within the country and from abroad - who the US believes could potentially turn into future leaders.
However, at the start of the meeting it was not immediately clear which Iraqi groups were attending the talks.
Representatives of the Iraqi National Congress are there. But the group's leader Ahmad Chalabi - widely seen as a Pentagon favourite to lead Iraq - appears to be absent.
At least one Shia group is reported to have boycotted the talks.
Monday's talks coincide with Saddam Hussein's birthday, an occasion marked in the past with massive state-organised celebrations.
Zubaidi has been removed from Baghdad, the US says
But, on his 66th birthday, the ousted Iraqi leader's fate is unknown.
US-led forces now control the country, but are still facing street protests in the capital.
The latest came as delegates arrived at the conference hall, when hundreds of Shias held a rally saying clerics from the holy city of Najaf were not properly represented at the talks.
Demonstrators also raised banners in support of the self-proclaimed "mayor" of Baghdad, Mohammed Mohsen al-Zubaidi, arrested by US forces on Sunday.
The US accuses him of trying to sabotage coalition efforts to restore basic services to the war-torn capital.
"Zubaidi sent letters to individuals and organisations telling them not to go back to work at utility plants (power, water, sewage) and banks, unless he approved it," the US statement said.
US military officials said they were committed to helping Iraqis form their own government, but until that time the coalition was the only legitimate authority in the country.
Meanwhile, the first democratic elections in Iraq since the fall of Saddam Hussein are reported to have been held in a city near
Abu Ghraib, a city of more than one million people about 20 kilometers (12 miles) west of the capital, is said to have elected a city council in a poll which US officials helped organise.
In other developments:
- US Defence Secretary Donald Rumsfeld describes the war in Iraq as an historic success and says his country has entered a new era in which it must defend itself with pre-emptive action, as he tours the Gulf region
- UK Prime Minister Tony Blair says the hunt will continue for any chemical or biological weapons remaining in Iraq.
- The US says it has taken into custody General Hossam Mohammed Amin, the former director of Iraq's arms monitors and the six of clubs in the US "most wanted" playing card deck
- Mohamed ElBaradei, the head of the UN nuclear watchdog agency, calls for UN weapons inspectors to return to Iraq as soon as possible
- The commander of British
forces in the Gulf, Air Marshal Brian Burridge, says he sees no sign that the Iranian
Government is meddling in Iraqi affairs - despite US claims to the contrary.