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LONDON (Reuters) - Londons dominance of the multi-trillion dollar global derivatives market is at risk after a regulator said on Wednesday banks in the EU will have to use trading platforms within the bloc after the completion of Brexit on Dec. 31.

FILE PHOTO: The City of London financial district is seen amid the coronavirus disease (COVID-19) outbreak in London, Britain, November 24, 2020. REUTERS/Peter Nicholls/File Photo

The City of Londons unfettered access to the European Union, its biggest customer, ends when the Brexit transition arrangements expire, and Brussels wants trading in euro-denominated derivatives to remain within its jurisdiction or in a country with equivalent standards to the bloc.

The Paris-based European Securities and Markets Authority (ESMA) on Wednesday confirmed that from Jan. 1 EU investors would have to use a swaps platform inside the bloc, or based in a non-EU country such as the United States that has already been granted equivalence or permission.

This means that branches of EU banks in London will face conflicting EU and British requirements on where to trade derivatives.

The City of London touts itself as the go-to location globally for trading derivatives - the life blood of financial markets, allowing investors to bet on a swathe of assets and hedge risk.

The decision is a starting gun for a fight between the UK and the EU for the location of international derivatives trading in Europe, said Michael McKee, a financial services lawyer at DLA Piper law firm, adding that France and Germany hoped to pick up the spoils.

Banks have already been moving some positions in derivatives from London to the new EU hubs ahead of Brexit.

While the rules would not create the sort of systemic disruption of areas such as clearing the contracts, which has already been smoothed over with temporary equivalence, it does signal that the EU is prepared to play hardball as Brexit injects a sense of urgency into reducing its reliance on the City of London for core financial services for its economy.

ESMA acknowledges that this approach creates challenges for some EU counterparties, particularly UK branches of EU investment firms, the watchdog said.

Britains Financial Conduct Authority said it would not be adjusting its approach to derivatives trading at this time.

Mutual equivalence would be the best way to avoid market disruption and meet international G20 commitments. We continue to monitor market developments, the FCA said.

The derivatives industry has urged Brussels to avoid a clash in rules through a quick fix legal workaround, but it now appears this was not possible.

The rules mean British counterparties will have to use a UK authorised platform, while EU counterparties have to use an EU authorised platform, making a trade between the two sides impossible. You cant tick both boxes, a derivatives sector official said.

Again, this is the EU telling the UK - this is your mess, you can sort it out, said Jake Green, a regulation lawyer at Ashurst law firm.

The ESMA said it did not see room for providing different guidance based on the current legal framework, and in the absence of an equivalence decision by the European Commission.

The ongoing trade talks between the EU and Britain do not cover financial services, though a deal could help the mood music towards financial services access.

The International Swaps and Derivatives Association (ISDA) said no equivalence would mean fragmenting liquidity, raising costs and probably a negative effect on pricing of contracts for end-users.

It means EU and UK firms would not be able to trade derivatives that are subject to both EU and UK trading obligations unless they trade on a U.S. swap execution facility, but that may not be practical or even possible for some, said Roger Cogan, ISDAs head of European public policy.

Given the rules on trading venues in the EU and UK are virtually identical, we think equivalence is justified and necessary, Cogan said.

Reporting by Huw Jones; Editing by Carmel Crimmins, Alison Williams and Gareth Jones

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EU derivatives decision leaves London in the lurch - Reuters