(Adds dropped word in paragraph 7)
By Michael Shields
ZURICH, June 26 (Reuters) - A row over a stalled partnership treaty between Switzerland and the European Union is about to touch off a battle over share trading rules that could cause market ructions across Europe from July 1.
The pact with Switzerland that Brussels has sought for a decade and which was negotiated over 4-1/2 years would effectively cement the non-EU member state's participation in the EU single market, the biggest outlet for Swiss exports.
But political resistance to the treaty in Switzerland has held up the process. As a result, a frustrated EU says it will not recognise the Swiss stock market's rules as "equivalent" to its own beyond the end of June.
The Swiss government has responded with countermeasures, including a new system from July 1 that requires foreign stock exchanges to get Swiss permission to host trading in Swiss stocks.
Wilful, as well as negligent, violations of the Swiss requirements could result in criminal charges and even jail.
The EU's decision not to recognise the Swiss stock market regulations' so-called equivalency beyond the end of June will effectively prevent EU-based banks and brokers from trading on Swiss exchanges. They traditionally generate more than half the turnover on Swiss stock markets.
The new Swiss regime, which aims to head off a possible liquidity crunch and to steer share trading to Swiss markets, requires foreign exchanges to get Swiss permission to host trading in Swiss stocks. Trading venues outside the EU would get a green light to carry on as before.
Barring an unlikely last-minute deal, pan-European stock trading platforms Aquis Exchange Plc, Cboe Europe and the London Stock Exchange will not be able to host trading in Swiss equities from July 1.
Such venues host a third of Swiss equities trading volume.
Foreign trading venues, including stock exchanges and so-called multilateral trading facilities will be affected. Switzerland will let them host trading in Swiss-registered companies like Nestle, Roche and Novartis only if the foreign venues' regulations do not curb trading of Swiss stocks in Switzerland.
Markets outside the EU will not be affected. Once Brexit takes effect, British share trading platforms could be certified provided their regulation does not interfere with trading on Swiss markets.
Wilful and negligent violations of the Swiss rules could result in criminal charges. Sanctions can target foreign trading venues as well as their management or board of directors. Intentional violations can trigger imprisonment of up to three years or a fine; negligence could be punished with a fine.
WHY IS THE EU-SWISS TREATY SO CONTROVERSIAL?
The Swiss/EU deal would have Switzerland routinely adopt changes to single market rules. It would also create a more effective platform to resolve trade disputes and open a path to new trade deals such as an electricity union.
The pact would be an over-arching accord above a patchwork of 120 separate deals that already govern bilateral Swiss/EU ties and which emerged after Swiss voters in 1992 rejected plans to join the European Economic Area. These individual agreements were crafted when Switzerland still aimed to join the EU, a goal it has since dropped.
But the trade deal has become tangled up in domestic politics in Switzerland, which has parliamentary elections on Oct. 20. Those opposed to the EU trade deal range from the right-wing Swiss People's Party (SVP) to the centre-left Social Democrats (SP) and their allied labour unions.
The anti-EU SVP resents giving Brussels any say in Swiss affairs, while the left is dead set against diluting Swiss labour rules meant to protect Europe's highest wages from potential cut-rate EU workers on temporary cross-border assignments. That is a key demand from Brussels, which wants to avoid being soft on the Swiss with a potentially messy Brexit looming.
In theory, indefinitely, but both sides have said they are open to talks to break the logjam. In effect, the next deadline for Switzerland to sign the treaty and start the ratification process is the end of October.
That is when European Commission President Jean-Claude Juncker, a self-declared Swiss ally, leaves office and when a no-deal Brexit seems increasingly likely. But Swiss officials say there is no point signing a deal that is doomed to fail in parliament or get shot down by voters under the Swiss system of direct democracy.
Reporting by Michael Shields. Editing by Jane Merriman