Concerns over the AI bubble give rise to new types of credit derivatives
Bond investors are concerned that in order to develop the most advanced artificial intelligence technology, the world's leading tech companies will continue to issue large amounts of debt until they come under financial pressure.
This concern has injected new vitality into the credit derivatives market. Institutions such as banks and investors can use these tools to hedge risks and guard against rising borrower debt and declining repayment ability. According to data from the Depository Trust & Clearing Corporation (DTCC), a year ago, many highly rated tech giants did not have corresponding single-name credit derivatives, but now they have become some of the most actively traded contracts outside the US financial sector.
Data shows that contracts related to Oracle Corporation (ORCL) have been actively traded for months, and in recent weeks, trading of contracts related to Meta Platforms, Inc. (META) and Alphabet Inc. (GOOG, GOOGL) has also surged. After excluding offsetting trades, the notional debt covered by Alphabet’s outstanding credit derivatives is about $895 million, while Meta's is about $687 million.
Investors say that total investment in the AI sector is expected to exceed $3 trillion, with a large portion financed by debt, and demand for hedging will only continue to grow. A group of the world's wealthiest tech companies is rapidly becoming the most indebted.
PGIM Fixed Income co-chief investment officer Gregory Peters said:
“The scale of capital expenditures by hyperscale cloud providers is enormous, and follow-up investments will only increase. This makes one wonder: do you really want to be exposed to risks in this sector without any hedging?” He noted that relying solely on credit derivative indices that cover a basket of targets to provide overall default protection is no longer enough.
DTCC data shows that by the end of 2025, there will be six dealers quoting credit default swaps (CDS) for Alphabet, up from just one in July last year; Amazon’s quoting dealers have increased from three to five. Some institutions have even launched cloud provider CDS basket products, benchmarked against fast-growing cash bond baskets.
Last fall, as tech giants' financing needs came into focus, trading activity in related products surged. One Wall Street trader said their trading desk can now regularly quote $20 million to $50 million for most of these names, whereas there was almost no trading in these names a year ago.
Currently, cloud providers still have smooth access to bond market financing. This week, Alphabet issued $32 billion in bonds in three currencies, which was several times oversubscribed within 24 hours, and also successfully sold century bonds—an astonishing move in the fast-evolving tech sector, where companies can quickly become obsolete.
Morgan Stanley expects that these so-called hyperscale cloud providers will issue $400 billion in bonds this year, up from $165 billion in 2025. Alphabet said its capital expenditures this year will reach $185 billion, mainly for AI infrastructure.
This frenzy is exactly what some investors are worried about. London-based hedge fund Altana Wealth bought default protection on Oracle last year, with a five-year cost of about 50 basis points per year, meaning an annual payment of $5,000 per $1 million of risk exposure. That cost has now risen to about 160 basis points.
Bank Demand
Banks underwriting cloud provider debt have recently become important buyers of single-name CDS. Data center and other project financings are huge and move quickly, so underwriters often need to hedge their own balance sheet risks until related loans are fully syndicated.
Matt McQueen, head of credit, securitized products, and municipal banking at Bank of America, said:
“Project loans that were originally expected to be distributed within three months may now take nine to twelve months. So you’re likely to see banks hedging some distribution risk in the CDS market.”
Wall Street dealers are stepping up to meet this hedging demand.
Paul Muth, former head of US fixed income and global fixed income sales at Toronto-Dominion Bank, said:
“Market demand for new types of basket hedging tools is expected to continue growing. The increasing activity in private credit transactions will further generate targeted hedging demand.”
Some hedge funds see the hedging needs of banks and investors as profit opportunities. Andrew Weinberg, portfolio manager at Saba Capital Management, calls many CDS buyers “inelastic demand clients,” such as bank credit departments or credit valuation adjustment teams.
Weinberg said most large tech companies still have relatively low leverage, and bond spreads are only slightly below the corporate index average—this is why many hedge funds, including himself, are willing to sell protection.
“If tail risk scenarios occur, where will these credit bonds go?
In most scenarios, giants with strong balance sheets and trillion-dollar market caps will perform better than the overall credit market.”
However, some traders believe that the current bond issuance boom reveals market **complacency** and mispricing of risk.
Rory Sandilands, portfolio manager at global insurance company NN Group, said:
“The potential issuance scale is extremely large, which means that these companies’ credit risk profiles may come under some pressure.” He said he holds more CDS trades now than a year ago.
Weekly Market Review
- Alphabet issued nearly $32 billion in bonds in less than 24 hours, highlighting the huge financing needs of tech giants for the AI race and the strong absorption capacity of the bond market. Its GBP- and CHF-denominated bonds are the largest corporate bonds ever in their respective markets, with the sterling bond including a rare century bond.
- After the merger of Elon Musk’s SpaceX and xAI, banks are planning potential financing schemes to reduce the group’s high interest costs in recent years.
- Private equity investors about to acquire Electronic Arts are pushing for debt buybacks, which has hit the company’s bonds hard, and bondholders are joining forces to respond.
- Citadel has accused former portfolio manager and now Marshall Wace global head of credit Daniel Schatz of “shamelessly violating” employment agreements and stealing confidential information to build a team for competitors.
- Due to investor concerns about private credit funds’ software sector exposure amid the AI shock, Wall Street dealers are demanding higher premiums to trade related corporate bonds.
- Convergix Group paid a high price to refinance in the face of market concerns that AI will impact its business.
- Deutsche Bank says the software and technology sectors pose one of the most severe concentration risks ever seen in the speculative-grade bond market; UBS points out that the credit market has not fully priced in the disruptive risk of AI, and any problem with corporate bonds will further increase corporate financing difficulties.
- Apollo Management is providing $2.4 billion in debt financing to Vantage Data Centers, with part of the funds supporting infrastructure construction for Oracle’s collaboration with OpenAI.
- Nvidia’s planned data center project issued $3.8 billion in junk bonds, receiving about $14 billion in subscriptions.
- A real estate company leasing facilities to AI computing power operators has received the highest credit rating from one of the three major rating agencies for the first time.
Personnel Changes
- Citadel Securities, owned by Ken Griffin, has recruited Morgan Stanley’s Richard Smillie as global head of structured products.
- DWS Group has appointed Deutsche Bank veteran Oliver Reßowatz to oversee private market products and European credit business.
- Wells Fargo Investment Institute has named Luis Alvarado as co-head of global fixed income strategy.
- Bain Capital has hired Brookfield Asset Management managing director Michael Horowitz as a partner for special situations business.
Editor: Guo Mingyu
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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