Analysis: Cameron puts Britain offside and offshore in Europe

LONDON (Reuters) - David Cameron has put Britain offside and offshore in Europe.

In his failed last-minute quest for special treatment over financial regulation, the prime minister has taken Britain out of the room where decisions on the future of Europe will be shaped.

The consequence could well be a prolonged, bitter parting of the ways between the British and the rest of the European Union, culminating in an acrimonious divorce in which both sides lose.

The cheers of British Eurosceptics for Cameron's veto of EU treaty changes to allow the countries that share the euro single currency to pursue closer fiscal union were echoed by cries of "good riddance" in much of mainland Europe.

How this can safeguard the interests of the City of London financial centre is a mystery, not least to some of the bankers and executives whose much criticized sector accounts for 10 percent of the British economy.

"No matter what happens now, the UK has isolated itself and lost critical influence for no gain whatsoever," said Sony Kapoor, head of the Brussels economic think-tank Re-Define.

Britain is already seen by many as a free-rider, enjoying the benefits of being the euro zone's principal financial centre without the responsibilities of membership, while refusing to contribute to rescue packages for indebted countries.

The UK does pay a small share of loans to Greece and Portugal via the International Monetary Fund, and it lent money bilaterally to Ireland, a neighbor and big trade partner, but it is refused to pay into the euro zone's bailout fund.

Former U.S. ambassador to London Raymond Seitz wrote in his 1998 memoir "Over Here" that Britain's usefulness as an ally was directly linked to its clout in the EU. "If Britain's voice is less influential in Paris or, it is likely to be less influential in Washington."

If the country is perceived as being on its way out of the EU in the longer term due to the deepening hostility of Cameron's Conservatives and of public opinion, it will also be a less attractive investment destination.

As Tom Brown, a London-based senior executive with a German bank, wrote in a letter to Britain's Financial Times, "the talk of "safeguarding" the City misses the point, as the City can only maintain its ascendancy in financial services if the UK is a fully committed member of the European Union."

French President Nicolas Sarkozy said Cameron had picked the wrong time to seek special protection for bankers, hedge fund managers and tax shelters which citizens across Europe believed needed more regulation, not less, in the wake of the global financial crisis.

Sarkozy achieved a long-standing goal of French policy due to Cameron's stance, with the emergence of a hard core intergovernmental Europe centered on the euro zone with Britain on the outside.

Ironically, Kapoor noted, Britain is actually pursuing stricter rules for bank capital requirements, liquidity and the separation of retail banking from investment banking than the EU authorities are proposing.

Britain, home to roughly half the EU's financial services business, had sought veto rights over four areas of legislation, including on a European effort to curb so-called "gold plating" of community rules by adding tougher national standards.

In fact, Britain has never been outvoted on matters of financial regulation of interest to the City, EU officials say. It can usually count on allies such as Ireland, Sweden, the Netherlands and several central European states to help it block unwelcome legislation in embryo.

British-trained technocrats have played a central role in the European Commission's financial services unit, ensuring that EU directives take account of the concerns of the financial services industry from their drafting.

Indeed Brussels has often been criticized in continental Europe as too liberal on deregulation, especially under previous Internal Market Commissioner Charlie McCreevy of Ireland, whose personal motto was "regulate in haste, repent at leisure."

The current director-general for the Internal Market and Services, Jonathan Faull, a Briton, and was chosen partly to counterbalance Internal Market Commissioner Michel Barnier, a Frenchman regarded in London as hostile to the City.

Furthermore, the most influential European Parliament lawmaker on financial services is Malcolm Harbour, a British Conservative, chairman of the Committee on Internal Market and Consumer Protection. City lobbyists are omnipresent in the corridors of Brussels, with easy access to the Commission and the legislature.

Britain has not been voted down once by other EU states on any financial regulation issue since Barnier took over, opting for compromise instead. But experts say its ability to muster a blocking minority of allies was waning because of the political unpopularity of banks and hedge funds.

It recently failed to stop continental countries imposing a temporary ban on so-called naked short-selling of credit default swaps on sovereign debt -- selling insurance contracts on government debt without owning the underlying assets with the intention of buying them back at a lower price.

As Britain absorbed the shock of its near total isolation in Europe at the weekend, Chancellor of the Exchequer (finance minister) George Osborne denied that London has lost influence.

"We have protected Britain's financial services and manufacturing companies that need to be able to trade their products into Europe from the development of euro zone integration spilling over and affecting non-euro members of the EU," he said.

Such confidence appears to be based on the assumption that other European countries will be unable to use the core EU institutions - the Commission and the European Court of Justice - to enforce their own agreements without Britain's consent.

That may be tested both politically and in the courts. With at least 23 and perhaps 26 of the 27 EU members forging ahead with a separate fiscal union treaty soon, they will want to use existing EU institutions rather than duplicating them.

They may also seek to handle issues such as banking resolution and deposit guarantees inside the euro zone in future.

Economist Nicolas Veron of the Bruegel think-tank argues that some of this could be done without treaty change, for example providing supranational guarantees to national deposit insurance schemes, to forestall the risk of catastrophic retail bank runs in troubled countries.

So while there is no imminent threat to the free movement of capital or goods in the single market, the result of Cameron's veto may well be to hasten a tightening of financial regulation inside the euro zone to the detriment of the City.

(Writing by Paul Taylor; editing by Philippa Fletcher)

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