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UPDATE 1-EXCLUSIVE-EU Parliament expected to soften euro clearing relocation powers

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* Leading lawmaker pushes for changes on clearing relocation

* Plans could weaken EU clout over post-Brexit London

* Move could reduce chances of LCH clearing relocation to EU (Adds detail.)

BRUSSELS, Jan 12 (Reuters) - The European Parliament is aiming to soften plans to give European Union regulators the power to force London's main clearing house to relocate if it wants to continue doing business in the single market after Brexit, an EU lawmaker said.

Euro clearing is one of the main battlegrounds between London and Brussels in divorce talks that will shape how Europe's financial market is divided up when Britain leaves the European Union.

The European Commission proposed in June to give broad powers to itself, the European Central Bank and the European Securities and Markets Authority allowing them to force foreign clearing houses deemed "substantially systemically important" to move into the bloc, or face exclusion from the EU market.

"We don't want to give those bodies this right to use total discretion in deciding what is cleared where," Danuta Hubner, chair of the powerful constitutional affairs committee of the EU legislature, told Reuters.

Hubner, who is the leading EU lawmaker on clearing, said her report on the Commission's plan, due to be finalised by the end of January, will include stricter conditions for regulators to determine whether clearing should be moved.

She said she was confident parliament would back her amendments, although other prominent lawmakers have previously called for a sweeping relocation of euro business from London to the EU after Brexit.

Any new rules would also need approval from EU member states, which are competing to attract business from London, Europe's biggest financial centre, after Brexit.

If confirmed by parliament, Hubner's unexpected move is likely to be welcomed by the financial industry, which has warned that forced relocation could split markets, increase trading costs and diminish the status of the euro - besides threatening thousands of jobs in the City of London.

At the moment, most derivatives denominated in euros are cleared in London through LCH, a subsidiary of the London Stock Exchange which reported record volumes last year across multiple clearing services.

Its interest rate derivatives clearing service, SwapClear, which dominates clearing of euro-denominated swaps or derivatives, processed trades with a notional value of more than $873 trillion in 2017.

LCH is the only clearing house operating in the EU that, once turned into a foreign company by Brexit, could be deemed substantially systemically important by EU regulators, Hubner said. Its German rival Eurex is a comparable size, but the new rules would not apply to it because it is in the EU.

"We take additional criteria, and among them is the costs for the economy," said Hubner, who is a former EU commissioner.

She said relocation decisions should also consider whether a service provided by a foreign clearing house could be replaced by companies within the EU. If not, the relocation could be put on hold, said Hubner.

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Clearing houses, also known as central counterparties, sit between two sides of a financial trade to ensure it is smooth and completed safely.

The importance of clearing houses to the financial system has increased since the global financial crisis because regulators around the world have pushed for more derivatives to be cleared by third parties in a bid to reduce risks.

LCH is currently one of 17 clearing houses authorised in the European Union. Another 28 foreign central counterparties in countries such as Hong Kong, Singapore, Switzerland and United States, are also allowed to operate in the EU.

Under the law proposed by the Commission, non-EU counterparties operating in the single market under a so-called equivalence regime and deemed "systemic" would be subject to stricter supervision.

The EU allows non-members to operate in the bloc if Brussels deems that the other country's legal and regulatory regime is at least as good, or equivalent, as its own.

Those counterparties classified as "substantially systemically important", however, could face relocation so they can be overseen more closely by the bloc's supervisors.

Hubner, a Polish lawmaker and member of the main centre-right political group in the EU parliament, said the decisions needed to be more evidence-based and the powers of EU regulators should be less discretionary than envisaged so far.

The Commission said in its June proposal that it would clarify criteria to assess the systemic importance of clearing houses in further regulations, expected six months after the draft law is adopted by the European Parliament.

The Commission's proposals need the backing of the Parliament and a qualified majority of EU states to become law.

Although her draft report on clearing could be seen as a boost for Britain, Hubner stressed that the country's financial sector was unlikely to be given special treatment in any new trade deal with the European Union.

She said the best option for Britain's financial interests would be to maintain full access to the EU market with an agreement similar to those the bloc has with Norway and Iceland.

Such a deal would imply that Britain would have to make contributions to the EU budget and accept the jurisdiction of the EU Court of Justice - options the British government has ruled out so far.

Hubner also said the EU parliament wants agreements on several issues such as data protection and customs, as well as clearer rights for EU citizens in Britain, before it could approve any Brexit trade deal. (Reporting by Francesco Guarascio; additional reporting by Huw Jones; editing by David Clarke)