* U.S. move could unlock billions in frozen funds
* Clinton seeks to send message to Gaddafi
* Rebel council seen emerging as legitimate government (adds quotes, detail)
By Andrew Quinn
ISTANBUL, July 15 (Reuters) - The United States Friday recognised Libya’s rebel National Transitional Council (TNC) as a legitimate government, a diplomatic boost which could unlock billions of dollars in frozen assets.
U.S. Secretary of State Hillary Clinton said Washington would extend formal recognition to the Benghazi-based TNC until a fully representational interim government can be established.
“The TNC has offered important assurances today, including the promise to pursue a process of democratic reform that is inclusive both geographically and politically,” Clinton said in prepared remarks.
“Until an interim authority is in place, the United States will recognise the TNC as the legitimate governing authority for Libya, and we will deal with it on that basis.”
Clinton’s announcement came as the Libya Contact Group, meeting in Istanbul, formally recognised the opposition as the representative of the Libyan people — sealing its diplomatic status as the successor government to embattled leader Muammar Gaddafi.
The contact group, made up of more than 30 governments and international and regional organisations, also authorised U.N. special envoy Abdul Elah Al-Khatib to present terms for Gaddafi to leave power in a political package that will include a ceasefire to halt fighting in the civil war.
Clinton said any deal “must involve Gaddafi’s departure” from power and a halt to violence.
“Increasingly the people of Libya are looking past Gaddafi. They know, as we all know, that it is no longer a question of whether Gaddafi will leave power, but when,” she said.
U.S. officials said the decision on formal diplomatic recognition marked an important step toward unblocking more than $34 billion in Libyan assets in the United States but cautioned it could still take time to get funds flowing to the cash-strapped Benghazi council.
“We expect this step on recognition will enable the TNC to access additional sources of funding,” Clinton told reporters after the meeting, saying Washington would discuss with allies “the most effective and appropriate method” to do this.
They also said no decisions had been made on upgrading U.S. representation in Benghazi — now a small office headed by special envoy Chris Stevens — or on bringing the TNC into the United Nations and other international organisations.
Clinton acknowledged that the United States had “taken its time” in deciding on formal recognition of the TNC, but now firmly believed this was the way forward.
“We think they are have made great strides and are on the right path,” she said.
U.S. President Barack Obama signed an executive order on Feb. 25 freezing the assets of Gaddafi, his family and top officials, as well as the Libyan government, the country’s central bank and sovereign wealth funds.
Most of the frozen assets are liquid in the form of cash and securities.
U.S. officials have pledged to free up some of the money for the TNC, which has run dangerously short of cash to pay for salaries and basic services even as it takes on more of the responsibilities of government.
But discussions with Congress on mechanisms to free up the money ran into legal complications — some of which could be swept away by U.S. recognition of the TNC as Libya’s legitimate government.
“Our hope is that in a relatively short time frame we will be able to make progress (on funds) but there’s a lot of moving pieces here,” one senior State Department official said.
The United States could direct banks to transfer frozen funds directly to the TNC, but this might still run foul of U.N. financial sanctions in place on Libya.
A second option would be for the United States to establish a line of credit backed by the frozen assets as several other countries have done.
Clinton’s announcement formally recognising the TNC marked the end of a process which began in February when Obama declared that Gaddafi had lost his legitimacy as Libya’s leader because of his brutal response to anti-government protesters.
“We wanted to send a very clear signal to Gaddafi and the people around him that we are looking past Gaddafi to a future without him,” the senior U.S. official said. “We felt that taking this step today sends that message loud and clear.”
The United States closed its embassy in Tripoli in February and withdrew its diplomatic staff, but maintains embassy staff working in Washington to develop ties with the TNC.
The United States and Gaddafi’s government have been estranged for most of the past four decades, and only resumed contacts in 2003 when Tripoli gave up its pursuit of weapons of mass destruction and took responsibility for its role in the 1988 bombing of Pan Am flight 103 over Lockerbie, Scotland. (Editing by Simon Cameron-Moore and Alison Williams)