Debt investors are growing increasingly concerned that the world’s largest technology companies will borrow staggering sums to fuel the race for artificial intelligence dominance, potentially harming their financial health. This anxiety is breathing new life into the market for credit derivatives, where banks and investors can buy protection against the risk of a borrower taking on too much debt and becoming unable to meet its obligations.
Just a year ago, credit derivatives tied to individual, high-grade tech firms were rare. Now, they are among the most actively traded contracts in the US market outside of the financial sector. According to recent data, contracts tied to nearly $900 million of debt from the parent company of Google are outstanding, with around $687 million linked to the parent company of Facebook.
This surge in activity is driven by the sheer scale of AI investment, which is projected to exceed $3 trillion, a sum largely expected to be funded by debt. “This hyperscaler thing is just so ginormous and there’s so much more to come that it really begs the question of ‘do you want to really be nakedly exposed here?'” commented a co-chief investment officer at a major fixed income firm. He noted that broad credit indexes are no longer sufficient for many investors, who now want targeted protection.
The number of dealers offering protection on these tech giants has grown significantly in recent months. Trading activity intensified last fall as the massive debt requirements of these companies became a central focus. One Wall Street dealer reported that their desk can now regularly handle trades of $20 million to $50 million for companies that barely traded in derivatives a year ago.
For now, these tech titans are having no trouble financing their ambitious plans. A recent multi-currency debt sale by one company drew orders many times larger than the $32 billion offered within a single day, even including the successful sale of 100-year bonds—an unusual move in a fast-moving industry.
However, the borrowing is set to accelerate dramatically. One financial institution forecasts borrowing by these massive tech companies, often called hyperscalers, could reach $400 billion this year, up from $165 billion the previous year. One company alone has stated its capital expenditures for AI development could be as high as $185 billion this year.
It’s this kind of exuberance that has some investors worried enough to buy protection. One London-based hedge fund, for example, purchased protection against a major software company defaulting last year. The cost of that protection has since more than tripled, indicating rising market concern.
Banks are also major players in this new derivative market. The institutions that underwrite the enormous loans for data centers and other AI projects are significant buyers of single-name protection. The deals are so large and moving so quickly that banks need to hedge their own balance sheets while they work to distribute the loans to other investors. “Expected distribution periods of three months could grow to nine to 12 months,” explained a head of credit banking at a major financial institution. “As a result, you’re likely to see banks hedge some of that distribution risk in the CDS market.”
Wall Street is rushing to meet the growing demand. One former senior fixed income executive predicted that appetite for newer, targeted basket hedges will continue to grow, especially as trading in private credit becomes more active. For some hedge funds, the widespread demand for protection from banks and investors isn’t a risk to avoid, but a fresh opportunity to profit.
