(Adds banking reaction, European Commission)
By Huw Jones
LONDON, June 16 Exempting British banks from planned European Union rules to curb risky trading would be illegal, the bloc's lawyers said on Monday in a legal opinion that marks another setback for UK attempts to limit Brussels' influence on the City of London.
EU financial services commissioner Michel Barnier has proposed a law that would slap curbs on so-called proprietary trading or banks taking bets on the market. It is similar to the Volcker Rule that the United States has already approved.
Britain has expected an exemption from core parts of the draft law because it has already approved a similar rule known as Vickers, which requires banks like Barclays to wrap their deposit-taking arms with a "ring fence" of extra capital so that customer money is safe even if the trading arm gets into trouble.
France was annoyed that the draft EU law as proposed contained a get-out clause - known as Article 21 - that effectively exempted Britain because it had passed its Vickers rule into law by a certain date.
"The derogation mechanism established in Article 21 of the proposed Regulation is not compatible with the legal basis of the proposal, with the nature of the proposed instrument as defined in the [EU Treaty] and with the general institutional principles established in the Treaties," the legal opinion seen by Reuters concludes.
Barnier's spokeswoman said the Commission would look at the opinion carefully and remains confident that its proposal is legally sound, and hopes to see negotiations to approve it progress quickly in coming months.
But Paul Chisnall, executive director at the British Bankers' Association, said the legal opinion forces the European Commission to go back to the drawing board and find a better way of accommodating EU states that have already taken steps to limit trading risks.
"The legal opinion... adds a layer of legal complexity on top of what was already a politically sensitive issue," he said.
A legal opinion from lawyers for the member states' council carries weight and will almost certainly force the European Commission to make changes to the proposal.
British Prime Minister David Cameron has pledged to negotiate a new "settlement" with the EU in order to curb its influence over the UK financial services sector, the EU's biggest and a major tax earner for Britain's Treasury.
The legal opinion will be another blow for Britain's attempts to limit the reach of EU rules on one of its most important economic sectors and may give more ammunition to the UK Independence Party, whose anti-EU stance helped it come top in the European Parliament elections last month in Britain.
The opinion, dated June 16, looks solely at the legality of Article 21 in the draft EU law to curb risky trading at banks.
It allows a member state which has already adopted laws with the same aims as the EU measure to ask the EU's executive Commission for an exemption from having to separate some trading activities from the main part of the bank.
The Commission has said this would allow states that have taken steps to curb risky trading to avoid costly alignment of existing, effective provisions with the bloc's proposed law.
To qualify for the exemption, national legislation must have been approved before Jan. 29, 2014 and fulfil certain criteria, conditions which bankers say Britain meets.
But the legal opinion argues that such an exemption lacks an objective justification, and includes a cut off date that is not explained.
"It is difficult to conclude that restructuring costs that are to be borne out by an admittedly quite limited number of credit institutions, which by definition are of a certain size and with consequential financial clout, would have any bearing on the economies of their host member state...," the legal opinion says.
Bowing to national law also goes against the principle of supremacy of EU law, it added, and suggested the exemption could be ditched, permitted for a limited period of time or have its cut-off date properly explained.
An EU official familiar with the draft law said the issues raised by the legal opinion could be dealt with. (Editing by David Evans/Mark Heinrich)