LONDON'S attempt to maintain its financial muscle while boycotting Europe's move toward a banking union risks isolating the city from its major trading partners and undermining its status as the world's top money center.

The European Central Bank will become the main regulator for the biggest banks in the 17-nation euro region as early as January 1, the first step toward a banking union, European Union leaders agreed last month. Britain has said it won't take part and is negotiating to retain London's influence within the single financial market.

The danger of a banking union that doesn't include the UK is that Britain's voice in setting the rule-making agenda will be weakened as the ECB gains new powers, bankers said. Trading in euros, now centered in London, could shift to Frankfurt or Paris and be regulated by the ECB, said Thomas Huertas, a former UK representative on the European Banking Authority, which drafts financial rules for the 27-nation EU.

"If there is a European banking union and a notable missing member of that is the UK, then that will likely hurt London as a major financial market," said Jay Ralph, the management board member responsible for asset management at Munich-based Allianz SE, Europe's largest insurer with 1.75 trillion euros (US$2.27 trillion) under management. "A strong pan-European banking union ex the UK will have negative implications for Europe and the UK."

London, the world's biggest center for foreign-exchange trading, cross-border bank lending and interest-rate derivatives, has 251 foreign banks and more international firms than any other financial center including New York or Frankfurt, according to TheCityUK, a bank lobbying group.

The City, as London's financial district is known, is home to three-quarters of the EU's foreign-exchange trading, including 42 percent of euro trades. Banks there conduct 62 percent of trading in euro-denominated, over-the-counter, interest-rate derivatives, the group said.

A European banking union that gives the ECB new supervisory powers will create an "inner core" of euro-region nations that sidelines the rest of Europe, including the UK, said Huertas, who now works for Ernst & Young LLP in London. Two sets of regulations for so-called inner and outer Europe would mean UK banks wouldn't have as easy access to European markets, he said.

"Most dollar capital-market business and most dollar business for the domestic US market occurs inside the United States," Huertas said. "It's entirely possible that euro business moves from London to the continent."

Single market

The concern for UK banks is that "you end up with a policy-weighting toward the eurozone banks because they're in aggregate bigger - that could damage the single market," Douglas Flint, chairman of London-based HSBC Holdings Plc, Europe's largest bank, said in an interview. A banking union "has to be done in a way that preserves the integrity of the single market in financial services so that banks within Europe but not within the banking union are not disadvantaged."

David Walker, chairman of London-based Barclays Plc, the UK's second-largest lender by assets, echoed Flint.

"Because we are not in the euro area, their shaping the union and equipping the European Banking Authority will be less sensitive to our concerns," Walker said on October 17 at a British Bankers' Association conference in London. "We will see some undermining of the single market, some protectionism of the financial-services sector."

Much of the structure and timing of a banking union remains to be negotiated, and that is adding to uncertainty in London, according to senior executives at US and European banks in the City, who asked not to be identified because they aren't authorized to discuss companies' positions.

In addition to common supervision, a banking union could mean that governments share the costs of winding down failed lenders and guarantee deposits, or leave that to national regulators. In the meantime, a central supervisory authority could allow the region's bailout fund, the 500 billion-euro European Stability Mechanism, to directly recapitalize firms, breaking the link between sovereigns and their lenders.

The UK doesn't want to be part of a banking union because it doesn't want to be responsible for paying for failed banks in Spain and elsewhere in the euro area, according to top government officials. Britain should stay outside because the plan is designed to address the "vicious circle" between sovereign debt and banks in those countries, Deputy Prime Minister Nick Clegg said in a speech last month.

"The worst outcome would be the creation of an over-powerful banking bloc," said Clegg, whose coalition government is facing pressure from inside the Conservative Party to hold a referendum on the UK's ties with the EU. "The rest of Europe needs to be crystal clear: If they integrate in a way that hurts the City, they potentially hurt Europe as a whole."

Charles Bean, deputy governor of the Bank of England, said the central bank shares the government's view that a banking union will help bring stability to the euro area and that UK banks shouldn't be a part of it. While the UK belongs to the EU, it opted out of the eurozone established in 1999.

"We don't particularly want to be part of it, so what will be important going forward is that we establish a modus operandi that ensures that decisions that are taken in the European banking union don't impinge adversely on the way the single market in financial services in Europe operates," Bean told SkyNews on Sunday.

May shift operations

US banks that have built securities-trading operations and European headquarters in Britain as a hub for the rest of the region share Ralph and Flint's concerns, according to an executive with knowledge of lobbying by US lenders who asked not to be identified because the effort is private. If a banking union were to leave London more isolated from the rest of Europe, foreign banks would consider shifting operations to within the eurozone, the executive said.

"A very large proportion of the City is made up of euro-area banks, and the question for them is whether being under one supervisory roof will deliver over time outcomes which affect their activities in the UK," said David Green, who spent 30 years as a senior supervisor at the BOE and then headed international policy at the Financial Services Authority, the UK's industry regulator.

Spokesmen for British banks including Barclays, Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc declined to comment, as did those for Citigroup Inc, JPMorgan Chase & Co and Deutsche Bank AG.

"The UK is host to the EU's main financial center, and it's essential that it's not sidelined in the making of regulations that affect it more than other countries," Anthony Browne, CEO of the BBA, an industry lobby group, said in an e-mailed statement.