AI’s Debt Shadow: Why Big Tech is Fueling a Credit Derivative Boom
The relentless pursuit of artificial intelligence dominance is pushing Big Tech companies to borrow at an unprecedented rate, sparking concerns among debt investors. This anxiety is, in turn, driving a surge in the market for credit derivatives, as financial institutions and investors seek to protect themselves against potential defaults.
The Rise of Hedging Demand
Credit derivatives, financial contracts that allow investors to transfer credit risk, are experiencing a renaissance. Contracts tied to single companies like Alphabet and Meta Platforms, largely absent a year ago, are now among the most actively traded US contracts outside the financial sector, according to the Depository Trust & Clearing Corp. The expectation of over $3 trillion in AI investments, much of which will be financed with debt, is only expected to amplify this hedging demand.
“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?’,” said Gregory Peters, co-chief investment officer at PGIM Fixed Income.
Expanding Dealer Networks and Trading Volumes
The increased interest is reflected in expanding dealer networks. The number of dealers quoting Alphabet credit default swaps (CDS) has risen from one in July 2025 to six at the conclude of 2025. Amazon.com Inc. Has seen a similar increase, with dealer participation growing from three to five. Trading volumes are also climbing, with some Wall Street desks regularly quoting markets of $20 million to $50 million for these names – trades that didn’t even exist a year ago.
Currently, hyperscalers are successfully securing financing. Alphabet’s recent $32 billion debt sale across three currencies was heavily oversubscribed. However, the sheer scale of borrowing is raising eyebrows. Morgan Stanley anticipates borrowing by these tech giants to reach $400 billion this year, a significant jump from $165 billion in 2025. Alphabet itself plans capital expenditures of up to $185 billion this year to fuel its AI build-out.
Banks Hedge Their Exposure
Banks underwriting hyperscaler debt are also becoming significant buyers of single-name CDS. Large deals and rapid project development are prompting underwriters to hedge their balance sheets until loans can be fully distributed. Distribution periods, initially expected to be around three months, could extend to nine to twelve months, further incentivizing hedging activity.
“you’re likely to see banks hedge some of that distribution risk in the CDS market,” said Matt McQueen, head of credit, securitized products and muni banking at Bank of America Corp.
Opportunities for Hedge Funds
The increased demand for protection is creating opportunities for hedge funds. Andrew Weinberg, a portfolio manager at Saba Capital Management, notes that many CDS buyers are “captive flow” clients, such as bank lending desks. Leverage remains low at most Big Tech companies and bond spreads are relatively tight, making some hedge funds willing to sell protection.
“If there’s a tail risk scenario, where will these credits go? In a lot of scenarios, the big companies with strong balance sheets and trillion dollar market caps will outperform the general credit backdrop,” Weinberg stated.
A Note of Caution
Despite the current optimism, some traders express concern about complacency and mispriced risk. Rory Sandilands, a portfolio manager at Aegon Ltd., believes the potential for substantial debt raises concerns about credit risk profiles. He has increased his CDS trades accordingly.
What are Credit Derivatives?
Credit derivatives are financial contracts whose value is derived from the creditworthiness of an underlying asset, typically a loan or bond. They allow investors to transfer the risk of default from one party to another. A credit default swap (CDS) is the most common type of credit derivative.
Pro Tip:
Understanding credit derivatives requires a grasp of financial risk management. They are complex instruments best suited for sophisticated investors.
FAQ
Q: What is driving the demand for credit derivatives on Big Tech companies?
A: Concerns about the increasing debt levels of Big Tech companies as they invest heavily in AI are driving demand.
Q: What is a credit default swap (CDS)?
A: A CDS is a type of credit derivative that allows an investor to transfer the risk of default on a debt instrument to another party.
Q: Are Big Tech companies struggling to borrow money?
A: Not currently. They are still able to access debt markets, but the scale of their borrowing is raising concerns.
Q: What does this imply for investors?
A: Investors should be aware of the potential risks associated with the increasing debt levels of Big Tech companies and consider their own risk tolerance.
Did you recognize? The market for credit derivatives has grown significantly since the 2008 financial crisis, with increased regulation and transparency.
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