British diplomacy will soon be tested to the limit as the government defends London's interests in the face of a welter of new regulations that will shape the financial services industry for a generation. After the worst financial crisis in living memory, there is no doubt that more effective supervision of financial markets is needed.

In adopting the Vickers Report's recommendations, the UK is already at the forefront of profound changes. It must now ensure that European policymakers recognise the City of London's value to the European economy and limit the damage that badly-constructed, over-zealous and seemingly retributive regulation might do to it.

Yet in defending Britain's national interest, David Cameron must resist populist pressure to drape the City in a Union flag. Instead, the prime minister should encourage European colleagues to recognise that the City – a global centre with a critical mass of people and technology – is a precious European asset. It needs to be cherished and promoted, much like the German car industry or the French aerospace sector.

National interest will and should drive the UK to redouble and refocus its efforts to ensure that London's success is regarded as a collective European triumph, from which all EU households, businesses and governments gain.

The sector accounts for 10 per cent of UK gross domestic product, generates a trade surplus greater than all other net exporting industries combined and sustains 1.6m jobs. Yet it is not credible to argue that the City is a purely domestic concern – externalities generated in the City affect the world. Indeed, given that financial regulation is now made in Brussels and exported to the UK, the City can only retain its position as the EU's global financial centre through the enlightened self-interest of other EU member states. Pressure on Mr Cameron to adopt a "Hands Off the City!" approach to financial services regulation is therefore misguided.

Britain must win each regulatory argument on its merits, as George Osborne, the chancellor, just did to great effect in Brussels over the financial transaction tax. This proposed unilateral tax would have caused business to migrate to other jurisdictions and led to a reduction in EU GDP, according to the Commission's estimates, of 1.76 per cent. Mr Osborne's arguments against it were compelling, with or without the threat of a British veto.

But the next year will be critical, with a review of the Market in Financial Services Directive and the European Market Infrastructure Regulation looming.

History is rich with examples of minor regulatory tweaks driving continental shifts in financial markets business. The UK must gently make the point that while hobbling London might be satisfying, it will not automatically cause business to migrate to Paris or Frankfurt. Indeed proposals that harm European finance are likely to do more harm to Frankfurt or Paris, as smaller players, than to London. Competition between EU financial centres is fading, just as the rivalries between London, Manchester and Liverpool once waned. The future is an inter-continental struggle between New York, a European hub in London, and centres in Asia.

This is not to say the UK should be Europe's only financial centre – that would be as absurd as saying the Germans should be the only carmakers. However, while Paris, Frankfurt and Milan will remain pivotal for their domestic economies, only London has critical mass as a EU-located global financial centre. Take the $24.7 trillion global market in over-the-counter interest rate derivatives. The UK's share rose to 46 per cent in 2010 from 35 per cent in 2001. Over that period, the US share rose to 35 per cent, while France's fell to 7.6 per cent and Germany's to less than two per cent.

This reflects the reality that financial centres need to be deep and concentrated, business hubs for their region, conduits for capital flows and pools of expertise and innovation. London has critical mass not just in banking; but also in fund management; trading in securities, derivatives and commodities; private equity and hedge fund management; carbon markets and maritime finance. It is a difficult time to make the case, but the UK must ensure that Europe sees the dangers of undermining the competitiveness of a great European success story.

The writer is a Conservative MP and an FT contributing editor