EU faces struggle to bridge divide with Britain
* Regulation chief to meet UK finance minister in London
* Two set to discuss reforms after recent EU summit split
* Smooth relations important in drive for financial reform
BRUSSELS/LONDON, Jan 20 (Reuters) - Michel Barnier, the official in charge of regulating finance in the European Union, meets George Osborne on Monday in what are likely to be tough talks over rules the British finance minister believes will hurt the City of London.
Relations between Brussels, where the European Commission sets the direction of regulation for banking and finance, and London, which fears losing its autonomy in supervising its powerful financial centre, have reached a low ebb.
At a December meeting of EU leaders, British Prime Minister David Cameron made a series of demands to shield the City, Europe's financial capital, from some EU rules in return for his backing for a treaty to underpin tighter state-budget controls.
But the demands, which one diplomat compared to seeking "offshore" status for London, were rejected in a split that saw Cameron leaving Brussels empty-handed and other EU countries left to press ahead for a fiscal pact without Britain.
Divisions with Britain place another obstacle in the way of Europe's drive to reform finance, a push some analysts believe had lost its way in the continuing banking crisis.
Next week's visit by Barnier to Chancellor of the Exchequer Osborne's official 11 Downing Street residence in London will be his first official meeting with Osborne since the December summit and an important opportunity to bridge the divide over the City, Europe's equivalent of Wall Street.
"The last few months have seen ups and downs in the UK-Commission relationship," said an EU official, speaking on condition of anonymity. "Commissioner Barnier is looking forward to seeing the Chancellor to discuss the many issues of common interest."
They will address divisive questions, such as EU rules that will dictate how much capital banks must set aside, and which Osborne wants to change before they are finalised to keep leeway to impose stricter standards on banks in Britain.
Barnier is also set to discuss the powers that a newly created pan-European watchdog will get in intervening in markets for trading derivatives, such as those that hedge the risk from price moves on oil, gas or other commodities.
Britain is keen to protect its hold on this $700 trillion market, which is mainly split between London and New York.
Osborne is worried about the influence of the Paris-based European Securities and Markets Authority over the City, which generated more than 60 billion pounds of taxes in the last financial year and accounts for 9 percent of Britain's economy.
He is determined to prevent what many UK politicians see as covert moves in Brussels to bolster three EU agencies created last year to supervise financial markets, banks and insurers.
One British official, speaking anonymously, expressed concern the new watchdogs were setting standards that are too rigid. "Rather than saying everyone must wear a suit, they are saying everyone must wear a Chairman Mao suit," he said.
Reaching compromise in the European Union, an alliance of 27 countries stretching from prosperous London to the crumbling streets of Bucharest, Romania, is not easy.
Next week's meeting brings together Barnier, a French politician close to former President Jacques Chirac who prefers talking in his mother tongue than English, with Osborne, an aristocrat educated at Oxford University.
Good relations between the two could be important in agreeing financial regulation.
The European Union has been struggling to catch up with the United States, whose lawmakers signed off on the so-called Dodd-Frank reforms in 2010 and are now racing to finalise the bulk of the new regime by the end of this year.
"Rightly the EU is looking at what it can do to improve regulation but it seems to be emphasising quantity at the expense of quality," Andrew Tyrie, Conservative chairman of the UK parliament's treasury committee, told Reuters.
Some rules could be better handled at the global or local levels, Tyrie said.
Some financial reforms in Washington go further than Brussels, with a rule banning banks from trading on their own account and by setting up a powerful resolution authority to take control of failing financial firms.
Barnier will find it hard to win friends in Britain.
"What are the reasons for British euroscepticism? History (World War II), geography (Britain is an island nation) and newspaper groups that want Britain to leave the EU," said Charles Grant of the Centre for European Reform, a London think tank. "And, for the past year or so, Michel Barnier."
"The perception in the City ... is that he is pursuing a Franco-German agenda to curtail its business."
Barnier will also visit the City to meet senior bankers, some of whom are uneasy about Britain's stand last year.
One financial lobbyist in London, speaking anonymously, described one of Cameron's demands for a veto over new rules from Brussels as "completely bonkers".
Chris Cummings, chief executive of TheCityUK, the main body for promoting London as a financial centre, said, however, that the government's stand had heightened the importance within the EU of keeping Britain onside.
"Since the December meeting what we have seen is (that) other European states are demonstrably keener to keep the UK inside the tent," he said. "The message we want Barnier to take back with him is that the City is a European asset." (Editing by Sinead Cruise and David Holmes)