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LONDON, Aug 23 (Reuters) - The UK's financial sector is seeking an "ambitious" trade pact between Britain and the European Union to try to prevent a costly shift of jobs and business to the continent once the country leaves the bloc, according to a draft report seen by Reuters.
Unless Britain negotiates new trading relations with the EU, banks, insurers and fund managers in Britain could be locked out of the bloc's markets when it leaves the EU in March 2019.
The International Regulatory Strategy Group (IRSG) said in the draft report, to be submitted to the British government in September, that such a trade pact would allow UK firms to operate in the EU without the cost of having a local license.
"The proposals in the report are intended to achieve a level of mutual access for EU and UK firms, which is as close as possible to the current levels of access that exist for such firms within the EU framework," the report said.
It admitted negotiating such a pact could be challenging. Other EU capitals have been vying to attract London's financial businesses since the Brexit vote.
Currently, banks authorized in London can "passport" or offer their services to customers across the EU without the need for a license in each country, but this will end when Britain leaves, forcing the country to agree new trading terms.
Initially, the financial sector called for continued full passporting rights after Brexit, which is being negotiated over two years since Britain triggered the process in March, following a referendum vote in June last year.
The new proposals mark a departure from that stance, a recognition that the EU is likely to rule out future passporting.
The IRSG is sponsored by the City of London Corporation, home to London's "Square Mile" financial district, and TheCityUK, Britain's most powerful financial lobby.
Its report sets out how a trade pact for financial services could be structured and policed by a new dispute resolution body with powers to sanction breaches.
Punishment could include withdrawal of mutual access rights, the payment of "compensation" in the form of offsetting trade benefits, or retaliatory steps, such as measures that affect an equivalent value of trade, the report said.
No such trade pact in financial services has been tried before and the report said it was "ambitious in its intent."
"The IRSG is aware that there will be challenges associated with developing the EU/UK Agreement... and require the parties to reach agreement on a number of novel issues in particular, with regard to allowing a firm from the other party to have access to their markets without having to obtain a local license."
The report said it may be "appropriate to have a lighter touch regime" for wholesale financial business between banks, but this would not be appropriate when retail customers are involved.
Recent EU proposals to supervise clearing houses in Britain after Brexit or move them to the EU because they clear large amounts of euro denominated derivatives raise "potential complication," the report said.
Britain and the EU could also create a "Financial Services Forum" to encourage "continuing alignment" by sharing information, and participating in the development of new laws and regulations.
The financial sector published an overview of mutual recognition in April, but the follow-up makes specific proposals.
Britain's finance ministry did not respond to a request for comment.
TheCityUK Chief Executive Miles Celic told Reuters he has already been making the case for mutual recognition during visits to Brussels and other European capitals. "The general response has been that while ambitious, it is not unrealistic," he said.
The future of London as Europe's financial center is one of the biggest issues in Brexit talks because it is Britain's largest export sector and biggest source of tax with rival cities battling to draw highly-paid banking jobs and the revenue that they bring with it.
Few banks and insurers believe such a trade pact can be in place by March 2019, and some have already announced they are opening locally licensed subsidiaries in the EU to avoid being cut off from customers on the continent.
The proposal comes as the financial sector is running out of time to shape government strategy; in October, Britain wants its divorce talks with Brussels to shift focus from exit bills to the future shape of trade relations.
Given its novelty, the trade pact could take years to negotiate even if there is goodwill in the bloc, bankers said.
But the proposals mark a formal rejection of relying on "equivalence," the EU's existing system of market access for companies from outside the bloc.
Equivalence in an adapted form is being promoted by Barney Reynolds, a lawyer at Shearman & Sterling, but dismissed by banks as too politicized and unpredictable.
"I don't fault them for asking, but a mutual recognition trade deal will be a difficult lift. It requires potential unanimity among EU states, while my proposal is executable and gets to the same place," Reynolds said.
Anthony Belchambers, a founder of the Legatum Financial Services Forum which researches Brexit's impact on the sector, said TheCityUK initiative is "both important and timely."
"But," he added, "we must be careful to ensure that the inevitable 'price' that will be exacted by Brussels for continued market access is justifiable and does not constrain UK sovereignty."
Some member states may balk at a trade pact which reduces the need for banks, insurers and fund managers to shift staff to the bloc after Brexit, Belchambers added. EU regulators have already warned that financial firms in Britain must sufficiently staff their new units in the bloc.
Bank of England Governor Mark Carney and Financial Conduct Authority Chief Executive Andrew Bailey have mooted a similar pact. But bankers involved say it might be hard to pull off as it has never been done before in financial services on such a scale.
"This is all new and this is our problem," a banker involved in the proposal said. "We are offering a new paradigm and it will be difficult." (Reporting by Huw Jones and Andrew MacAskill; Editing by Rachel Armstrong)