The Iraqi interior ministry has said it has drafted legislation regulating private security companies following a shooting allegedly involving a US firm.
Blackwater has the contract to guard US diplomats in Iraq
The new code would require contractors to be subject to Iraqi law and to be monitored by the Iraqi government.
The draft is being considered by the consultative State Shura Council before being passed to parliament for debate.
The circumstances of the shooting two weeks ago, in which 11 Iraqis died, are being investigated by a US-Iraqi panel.
The contractor under suspicion, Blackwater USA, has said its guards reacted lawfully to an attack on a US diplomatic convoy.
A spokesman for the Iraqi interior ministry, Maj-Gen Abdul Kareem Khalaf, said the new guidelines would cover everything to do with the operations of private security contractors.
BLACKWATER USA FACTS
Founded in 1997 by a former US Navy Seal
Headquarters in North Carolina
One of at least 28 private security companies in Iraq
Employs 744 US citizens, 231 third-country nationals, and 12 Iraqis to protect US state department in Iraq
Provided protection for former CPA head Paul Bremer
Four employees killed by mob in Falluja in March 2004
"The companies will come under the grip of Iraqi law, will be monitored by the interior ministry and will work under its guidelines," he said.
"They will be strictly punished for any [violations] on the street."
Blackwater is the biggest private security firm operating in Iraq, with contracts including protecting the US embassy in Iraq and its diplomatic staff.
Tens of thousands of often heavily-armed security contractors work in the country.
Correspondents say their behaviour has incensed Iraqis who view them as private armies acting with impunity on their soil.
The contractors are currently granted immunity from prosecution under Iraqi law by Order 17 of the Coalition Provisional Authority - the now-defunct interim body set up by the US-led coalition in the wake of the fall of Saddam Hussein.
The agreement was extended shortly before the CPA was disbanded in June 2004.
Last week, Prime Minister Nouri Maliki called for the US government to end its contract with Blackwater immediately, although on Monday he agreed they should await the findings of the probe.