Obstacles still litter path to EU treaty pact

BRUSSELS (Reuters) - European leaders are lining up for a 'battle royale' over changes to the EU's treaty at a summit starting on Thursday as they seek to forge deeper integration in the euro zone and turn the tide of the debt crisis.

Competing visions are on offer about how to modify the Lisbon treaty, with France and Germany taking one line and European Council President Herman Van Rompuy another. In between, several member states have concerns about both views.

The ability of the euro zone to plot a path to closer economic integration, and in the process persuade financial markets that the currency project can survive, depends on whether leaders reach a meaningful consensus at the summit scheduled to end on Friday.

German Chancellor Angela Merkel and French President Nicolas Sarkozy agree that several changes to the EU treaty, which took eight years to negotiate, are needed to enforce stricter budget rules in euro zone states and prevent any future debt crisis.

"The current crisis has mercilessly uncovered the deficiencies in the construction of economic and monetary union," they wrote in a joint letter to Van Rompuy issued on Wednesday. Van Rompuy will chair the two-day summit.

"We need more binding, and more ambitious rules and commitments for the euro area member states... We propose that those new rules and commitments should be enshrined in the European treaties."

Van Rompuy does not disagree on the goal, but he differs on the best method of getting there.

In a report compiled after a week of consultations with all 27 EU leaders and which will form the basis of debate at the summit, Van Rompuy proposes using a 'fast-track' procedure to modify the treaty via a little-known section called protocol 12.

The protocol relates to euro zone countries under "excessive deficit procedure" for running up budget deficits that exceed three percent of gross domestic product.

By overhauling protocol 12 and strengthening other pieces of EU legislation such as the stability and growth pact on fiscal rigor, Van Rompuy says deeper budget and economic integration can be achieved rapidly and without as much disruption as a full-blown change to the treaties as urged by Paris and Berlin.

ALL NIGHT LONG?

The other advantage, his report suggests, is that 'surgical' modifications to protocol 12 would not require approval by all parliaments in the EU and would only require consultation from the European Parliament -- not that body's full approval, which could also take time and would be divisive.

"This procedure could therefore lead to rapid and significant changes," Van Rompuy said in the report, delivered to EU capitals on Tuesday.

However, Berlin hit back at the proposal almost immediately, with a senior German official telling reporters on Wednesday that this was not the way to go and that if necessary Germany and France would push for a treaty among the 17 euro zone countries alone, not the whole EU.

While Van Rompuy left open the possibility of jointly issued euro zone bonds, the German official also reaffirmed Berlin's view that the issuance of common euro zone debt would exacerbate the crisis rather than resolve it.

The official rejected a separate proposal to boost the firepower of the EU's bail-out fund by letting the European Financial Stability Facility (EFSF) run alongside the European Stability Mechanism (ESM) originally slated as its successor.

While Paris and Berlin want to show a united front, euro zone officials said there was no accord between them yet on removing the 500 billion euro ($669 billion) ceiling for the joint lending capacity of the EFSF and ESM as floated by Van Rompuy.

Germany also opposes an idea floated by Van Rompuy and backed by France, to give the ESM a banking license, so that the bailout fund could refinance itself at the European Central Bank's liquidity operations.

Other potential hitches abound as the first dinner encounter of EU leaders on Thursday nears.

While France and Germany are now proposing that any bailouts from the future ESM be agreed with an 85 percent majority, Finland on Tuesday fired back with a stiff defense of the rule of unanimity that still underpins much EU decision-making.

And while British Prime Minister David Cameron has backed EU treaty change as the most credible solution, he also warned that Britain would block that unless it won safeguards protecting national interests, notably the City of London financial sector.

"We do see it under continued regulatory attack from Brussels and I think there is an opportunity, particularly if there is a treaty at 27, to ensure some safeguards, not just for that industry but to give us greater power and control in terms of regulation here in this House of Commons," he told parliament.

With much still open to debate, the word in Brussels now is that Thursday's dinner could turn into an all-night affair.

(Writing by Luke Baker and Mark John)