In what has become one of the most widely read and distributed of our posts, we first introduced the world to the intricacies of legal 'subordination' and protection among European bonds back in January [4] of this year (and reaffirmed it specifically for Spain in early June [5]). This strategy proved exceptionally successful in the case of Greece [6], and has, in recent weeks, also done extremely well in the case of Spain. Since we first noted it, the local-law Spanish 2029s are down over 14% while the non-local 'UK-law' Spanish 2029s have managed to gain 1.1% providing arbitrageurs with a massive profit on a duration-matched low-capital pairs trade. More importantly, for all the European fixed income asset managers who owe their clients as least some fiduciary duty, we can only hope they rotated to the non-domestic-law bonds before early May - when trouble really hit. While gloating on one's success at non-vaporizing cash once again is not our way, we much more critically note that one can read the fundamentals (as opaque as they are and known to everyone [7]) or one can look at what the market is saying. What it is saying is that the differential between UK- and non-UK-law bonds has been crushed and is absolutely on a path to repeat the Greek PSI experience. There is plenty of room left for the trade since the UK-law bonds will likely be taken out at Par (just as with GGBs) while Spain's PSI is just as likely to be the 20s/30s - and any TROIKA funding will prime everyone but the UK-Law bonds.
Since our initial suggestion that arbs trade the pair and managers rotate their exposures...
[8]
and specifically in the last few weeks...
[9]
Charts: Bloomberg