By Brenna Hughes Neghaiwi

ZURICH (Reuters) - Switzerland's financial watchdog has scrapped plans that would have allowed the country's biggest banks and insurers to claw back bonuses in the event of staff misconduct.

The Swiss Financial Market Supervisory Authority (FINMA) on Tuesday nixed a clause in its revised rules for corporate governance, risk management and remuneration that told big banks and insurers to contractually reclaim bonuses already paid to staff in the event of a serious infringement of rules.

Financial institutions should still reduce or withhold current-year bonuses if staff break internal or external rules.

The new rules -- which were revised after industry input on draft proposals presented earlier this year -- take effect in July.

Many in the industry had criticized the retroactive clawback clause as ambiguous and legally impossible to enforce.

"An internal legal assessment has concluded it would be difficult to enforce on a legal and tax basis," FINMA wrote.

"Banks are nonetheless urged to check whether a clawback is possible in cases of violations, or specifically whether they are able to sue for damages."

The Swiss Bankers Association (SBA) had said clawbacks would harm the financial center's international competitiveness, while the Institute of Internal Auditing Switzerland said the clause conflicted with simple and transparent remuneration while introducing legal and tax dangers.

The rules are mandatory only for Switzerland's biggest banks and insurers, which include UBS <UBSG.S>, Credit Suisse <CSGN.S>, Swiss Re <SRENH.S> and Zurich <ZURN.S>.

Smaller banks, traders and financial groups are not obligated to enforce the rules, but instead are recommended to treat them as "best practice" principles.

(Editing by Louise Heavens)