EU diplomats deadlocked on bank watchdogs - sources

By John O'Donnell

BRUSSELS (Reuters) - European diplomats and lawmakers are deadlocked in talks to set up watchdogs for policing banks and others, sources familiar with the matter said, raising doubts over a key part of EU financial reforms.

Setting up supervisors to keep tabs on banks, insurers and market trading is crucial in Brussels' attempts to prevent another crisis but it is contentious with Britain, which does not want new super-watchdogs that could overrule London.

Now a row has started between the European Parliament and national governments over what powers to give the authorities and whether they should have the final say over regulators like the Bank of England or be able to ban risky financial products.

"I would say there is deadlock," said one person involved in the talks between parliament and EU states, of which both sides have an equal say in writing European Union laws. "The final stages of negotiation are difficult," said another.

Should the talks this week fail, it would be embarrassing for the Union, which has pledged to take a hard line on financial reform.

Representatives from the 27-country bloc including the president of its executive, Jose Manuel Barroso, and German Chancellor Angela Merkel travel to Toronto this weekend for a meeting of leaders of the Group of 20 most powerful economies.

Delays at home to financial reform would further undermine their authority, eroding any slim chance they have of persuading the gathering in Canada to back a global levy on banks.

At the heart of the disagreement, which could postpone negotiations until after the summer and drag out the planned starting date for the watchdogs beyond the beginning of 2011, is whether the watchdogs get powers to overrule states.

TAKING SIDES

The parliament, worried the new authorities will lack the teeth to enforce rules, want them to be able to instruct local regulators on what to do in an emergency.

Lawmakers also want the watchdogs to have the power temporarily to ban short-selling or products deemed dangerous.

Now Germany and France have sided with one another against Britain to back giving the new authorities these powers, said one source involved in the talks.

But Germany, said another, wants countries to have the power to block the new authorities.

Many fear such a veto -- triggered if a watchdog's ruling could force a country to spend money by demanding the rescue of a bank, for example -- would be abused and used as a wrecking ball to render the new authorities powerless.

Merkel, French President Nicolas Sarkozy and British Prime Minister David Cameron will attempt to settle their differences over this and other issues when they meet ahead of the G20 talks in Canada.

European countries are also uncomfortable with demands from European parliamentarians that all three new authorities be based in Frankfurt, Germany's financial capital.

"This is all about creating new institutions for Europe and taking away power from Britain," said one lawmaker involved in the talks. "But France has not thought through the implications of what it is asking for."

(Reporting by John O'Donnell, editing by Dale Hudson)