UPDATE 3-Telefonica, Telecom Italia tie up rattles Brazil

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SAO PAULO, April 30 (Reuters) - Spanish phone company Telefonica's (TEF.MC: Quote, Profile, Research, Stock Buzz) 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: Quote, Profile, Research, Stock Buzz), Brazil's No. 1 wireless carrier, with Portugal Telecom (PTC.LS: Quote, Profile, Research, Stock Buzz). 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: Quote, Profile, Research, Stock Buzz) 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: Quote, Profile, Research, Stock Buzz), 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.