UPDATE 3-Telefonica, Telecom Italia tie up rattles Brazil

(Adds closing share prices)

SAO PAULO, April 30 (Reuters) - Spanish phone company Telefonica's (TEF.MC) agreement to buy a controlling stake in Telecom Italia will shake up the vast telecommunications market in Brazil, Latin America's largest country.

Each European company owns a major Brazilian wireless company and fixed-line provider.

Telefonica shares control of Vivo (VIVO4.SA), Brazil's No. 1 wireless carrier, with Portugal Telecom (PTC.LS). The Spanish company also owns Telesp, Brazil's No. 2 fixed-line phone company, which operates in wealthy Sao Paulo state.

Telecom Italia (TLIT.MI) owns TIM Brasil, the No. 2 wireless company after Vivo. The Italian company also belongs to the controlling shareholders group of Brasil Telecom (BRTP4.SA), Brazil's No. 3 fixed-line company, which operates in the country's central and southern regions.

The tie-up between the Europeans, announced over the weekend, could conflict with regulations for Brazil's telecom sector and antitrust rules.

Brazilian regulations forbid phone companies from owning operating licenses in two different companies that provide services in the same area.

In the case of Vivo and TIM Brasil, both are essentially nationwide providers and their services might overlap. Vivo has 28 percent of Brazil's wireless phone market and TIM about 26 percent. Together, they would have some 54 percent of all wireless users and may raise red flags for antitrust authorities.

Traders speculated the government might pressure Telefonica to eventually divest from one of the two wireless companies. It could also try to dodge regulations by returning licenses for one of the two companies to the government while keeping newly acquired clients.

The regulatory uncertainties whipsawed share prices.

Shares of TIM Brasil (TCSL4.SA) rose as much as 5 percent before falling 3.95 percent to close at 7.30 reais. Its voting shares slumped 9.05 percent.

Vivo shares rose as much as 7 percent, but erased gains to close up 0.43 percent at 9.40 reais, as some traders bet Telefonica might be pressured to sell its stake to Portugal Telecom.

"The market thought Telefonica was going to buy out Portugal Telecom. Now, this (deal) is causing uncertainty," said Kelly Trentin, an analyst at the SLW brokerage.

Telefonica has said it will run the two companies independently, but Trentin said how this will be done remains unclear.

America Movil (AMX.N), which has invested heavily in Brazil and runs its No. 3 wireless provider called Claro, could face added competitive pressures because of the takeover.

Media relations offices in Brazil of Telefonica, Portugal Telecom and Telecom Italia were not available for comment. Claro's media office declined to comment.