By Francesco Guarascio
BRUSSELS (Reuters) - The EU is preparing to move its European Banking Authority from London following Britain's vote to leave the Union, EU officials said on Sunday, setting up a race led by Paris and Frankfurt to host the regulator.
Coming a day after Britain's Jonathan Hill resigned and was replaced as EU financial services chief by the Commission's "Mr. Euro" Valdis Dombrovskis, the move underlines how the City of London can expect to be frozen out of EU financial regulation -- and possibly from Europe's capital markets -- depending on the terms of Brexit.
While those who argued for Britain to leave the EU said the financial industry would thrive without EU shackles, some of its biggest employers including JPMorgan <JPM.N> are scouring Europe to find new locations for their traders, bankers and financial licenses.
The EBA, whose 159 London employees write and coordinate banking rules across the bloc, is expected to be relocated "soon", two EU officials told Reuters.
All European Union agencies are based in member states. EBA chairman Andrea Enria said before Thursday's referendum that the watchdog, founded in 2011 to improve regulation after the global financial crisis, would have to move if Britain chose to leave.
An EBA spokeswoman said on Sunday that the European Union will have to decide on relocation and in the meantime the agency would continue to operate in London.
Other European capitals are keen for a slice of Britain's financial services industry which contributed 190 billion pounds ($280 billion) to the economy in 2014, roughly 12 percent of economic output. Ireland said on Friday it had been in touch with firms considering relocating.
The industry employs 2.2 million people in Britain including around 90 percent of U.S. investment banks' European staff and 78 percent of capital markets activity by the other 27 members of the EU taking place in the UK.
Paris and Frankfurt are the two largest financial centers on the continent and are therefore seen as the most likely new locations for the EBA.
Italy's financial capital Milan could also put itself forward.
"There are several reasons to believe Milan is the right place. Competition from Paris and Frankfurt is tough, but they may neutralize each other," Italy's former prime minister Enrico Letta told Reuters on Sunday.
However, he said that any change was unlikely to happen quickly as it could fall under the negotiation of Britain's EU exit.
NO SPECIAL TREATMENT
The exit negotiations, expected to start once Prime Minister David Cameron has resigned, will be crucial for London's position as a leading financial center.
The leading "Leave" campaigner and favorite to become the next prime minister Boris Johnson, said Britain would continue to have free trade "and access to the single market".
But in Brussels, officials said it would be important to keep a tough line.
"The UK cannot expect special treatment for the City of London during the exit negotiations," said Sven Giegold, a German Green EU lawmaker.
Without a foot in the EU and the influence of Hill, a close Cameron ally, London's finance industry now faces a major disadvantage compared to other financial centers as the 19-state euro zone asserts its quasi-monopoly on EU financial business.
"The departure of Jonathan Hill marks the end of the multi currency union," one senior EU official said. "He was the symbol of the multi currency union and the appointment of Valdis Dombrovskis hands his role to the symbol of the euro."
Britain is also at risk of losing its prized "EU passport" if it fails to secure continued access to the bloc's single market.
Many U.S. and Japanese banks rely on the passport to operate across EU capital markets unhindered while basing most of their staff and operations in London.
The City could also lose its position as an important center for clearing financial transactions, the process of making sure that they proceed smoothly.
The European Central Bank has tried before to strip London of its lead role in this market, arguing that clearing houses dealing with euro-denominated transactions should be in the euro zone. The ECB is likely to take up the issue again now that London is no longer in the EU.
Britain also faces being shut out of the EU's most ambitious plan in years to tear down barriers to the movement of capital.
The Capital Markets Union (CMU), seen as highly beneficial to the City of London, was launched in September by the European Commission under Hill's oversight aimed at freeing up European capital markets by 2019.
Securities transactions are expected to surge in the EU as a result of that new financial infrastructure but London now looks unlikely to reap the benefits of this growing market.
However, among the promises to maintain a tough line in negotiations, there are also concerns that if Britain does not manage an amicable separation from the EU, including keeping some of its financial access rights, London could set itself up as an offshore rival for EU businesses less tolerant to regulation and tax.
That is "a scenario that cannot at the moment be ruled out," an EU official said.
(Additional reporting by Huw Jones in London; editing by Anna Willard)