The government's proposal for a new financial services arrangement post-Brexit will effectively make it more difficult for Britain's banks, insurers and asset managers to do business across the European Union.

The plan falls short of the current "passporting" rights that enable the country's financial services industry to trade freely with the EU.

The proposal, published in a White Paper, form part of Britain's negotiating position with Brussels over future trading relations.

"Today's Brexit white paper is a real blow for the UK's financial and related professional services sector," said Catherine McGuinness, City of London political leader.

The government has proposed expanding the EU's existing so-called "equivalence" regime, which currently covers access for non-EU partners like Japan and the United States to the region's financial services markets.

"As part of this, the existing autonomous frameworks for equivalence would need to be expanded, to reflect the fact that equivalence as it exists today is not sufficient in scope for the breadth of the interconnectedness of UK-EU financial services provision," the White Paper said.

The City of London financial district and TheCityUK, which promotes Britain as a financial centre, had jointly proposed a more ambitious "mutual recognition" blueprint to replicate the free access provided by passporting.

Under this plan, Britain and the EU would accept each other's financial rules to offer broad two-way market access.

But EU officials have opposed the idea, saying it would take away the EU's autonomy in rulemaking.

TheCityUK Chief Executive Miles Celic said the overriding issue for financial services firms was the ability to continue serving customers and clients.

"Mutual recognition would have been the best way to achieve this. It’s therefore regrettable and frustrating that this approach has been dropped before even making it to the negotiating table."

Banks and insurers in the City of London have been playing it safe by moving staff and opening hubs in the EU to make sure they still have access irrespective of the shape of Britain's new trading relationship with the bloc post Brexit.

The Investment Association, which represents fund mangers, said it was disappointing the government had ruled out mutual recognition as the preferred option.

A senior finance industry official said Britain was being pragmatic by putting the mutual recognition blueprint into language that Brussels was more familiar with to achieve a similar outcome.

But the official also said it would be a challenge to implement the plans before transition ends in 2020 given that the European Parliament goes to the polls and a new European Commission is appointed next year, which typically means months of legislative inactivity.

NO OUTSIDE LEGISLATORS

The City of London and TheCityUK have been lobbying the government for months to back their mutual recognition plan even though EU officials dismissed it because it offers the benefits of the single market without obligations or costs.

Only last month Treasury officials told senior financial sector executives that the government was planning to back their long favoured plan.

The Treasury said: "This proposal is the best option for getting a good deal for the City. It preserves the mutual benefits of integrated markets, protects financial stability, and preserves the City’s global reach."

Britain has rejected the current EU equivalence regime because Brussels alone decides who gets access. Under the new arrangement, Britain proposes safeguards, such as a bilateral agreement to make the system "stabler, transparent and predictable".

Lorraine Johnston, a lawyer at law firm Ashurst, said Britain was proposing a form of equivalence which gives it what looks like a seat at the European regulatory table, even if they cannot order from the menu.

"This looks like the UK's attempt to become the tail that wags the dog," Johnston said.

EU financial services chief Valdis Dombrovskis said on Thursday that the European Commission had already proposed enhancements to the equivalence system.

Pierre Gramegna, finance minister for Luxembourg, home to many funds managed from London, backed "enhanced" equivalence, but German finance minister Olaf Scholz said the EU must take its own decisions in financial regulation.

"There cannot be additional legislators on the outside," Scholz said.

Reuters reported last month that the bloc was opposed to changing equivalence solely for Britain, and that any improvements to its so-called equivalence regime would apply to other countries too.

The equivalence regime is already being revised since Britain voted to leave the EU to toughen up rules for "systemic" foreign financial firms or activities, such as the clearing of euro-denominated assets, which London dominates.

Failure to obtain generous access to EU markets could prompt calls for Britain to row back on financial rules to boost the City of London's competitiveness, a step British regulators have warned against.