AI debt boom revives credit default swaps, investors seek protection

Rising borrowing to finance artificial intelligence infrastructure is driving demand for credit default swaps linked to major technology companies, signalling growing investor caution over the scale and sustainability of the AI investment cycle.

The rapid expansion of artificial intelligence infrastructure is reshaping an important corner of the US credit derivatives market, with investors increasingly turning to credit default swaps (CDS) to hedge against the possibility of debt problems among major technology companies.

The Financial Times’ Alphaville column, citing data from Barclays, reported that the market for CDS linked to AI-related companies has expanded sharply over the past year. The growth reflects the enormous borrowing requirements associated with building data centres, acquiring advanced semiconductors and expanding computing capacity.

Companies across the technology sector are raising substantial amounts of debt to finance these investments. As borrowing increases, investors are seeking protection against the possibility that the AI spending boom could weaken companies’ balance sheets or fail to generate returns sufficient to justify the capital committed.

A credit default swap is a financial derivative that protects a borrower failing to meet its debt obligations. The buyer pays a recurring premium to the seller, who agrees to compensate the buyer if a specified credit event occurs.

Although often compared with insurance, CDS contracts can also be traded independently of the underlying debt. Investors do not necessarily need to own a company’s bonds to purchase protection, allowing them to take positions on whether its creditworthiness will deteriorate.

The cost of protection is generally quoted in basis points. For example, a CDS premium of 141.5 basis points on Nvidia means an annual cost of approximately $141,500 to protect $10mn of debt, according to the FT report.

CDS prices can therefore provide a real-time indication of how investors assess a company’s credit risk. However, rising premiums do not necessarily mean that a company is approaching default. They may also reflect greater demand for hedging or changes in market expectations.

The expansion is visible across several measures of the market. Barclays data cited by the FT show that the net notional value of CDS contracts linked to AI-related companies, excluding CoreWeave, has increased to nearly $30bn from less than $7bn a year earlier.

The 10 major hyperscaler and semiconductor companies tracked by Barclays now account for almost 14 per cent of the US single-name corporate CDS market, compared with about 4 per cent a year ago. Their share of trading volumes has also risen to approximately 20 per cent, around four times its previous level.

Open interest — the total value of outstanding contracts — for the AI-related group has climbed from roughly $7bn to more than $28bn over the same period.

These figures indicate that the growth is not limited to a temporary increase in trading. More investors are maintaining positions in CDS contracts linked to technology companies, while trading activity has become a larger part of the broader corporate credit derivatives market.

The market’s expansion has been particularly pronounced in contracts linked to Oracle and CoreWeave, although for different reasons.

Oracle has become one of the most active areas of the US single-name CDS market. Its four-week average weekly trading volume reached approximately $2.3bn, more than twice the levels recorded for Broadcom, Nvidia or Alphabet. Its open interest was close to $7bn, according to the FT report.

The scale of activity is notable because Oracle remains rated within investment-grade territory. Its borrowing requirements and exposure to large-scale AI infrastructure commitments have nevertheless attracted increased attention from credit investors.

CoreWeave, by contrast, stands out for the unusually high cost of insuring its debt. Its CDS pricing places it in a separate category from the larger technology companies discussed in the report, reflecting a more pronounced perception of credit risk.

CDS premiums linked to Broadcom and SpaceX have also risen. The developments suggest that investors are examining the financial implications of AI-related borrowing across different parts of the technology ecosystem rather than focusing exclusively on the largest semiconductor companies.

The Barclays analysis also identified differences between CDS pricing and the yields on bonds issued by some technology companies.

In certain cases, CDS contracts appear to reflect greater investor concern than the corresponding bonds. This creates a positive basis between the two markets, potentially presenting opportunities for investors seeking to exploit differences in pricing.

Oracle, Broadcom and AMD were among the companies where the basis was particularly elevated, according to the report.

Such discrepancies matter because CDS and corporate bonds provide different perspectives on credit risk. A widening gap can indicate that investors are using derivatives to express concerns that are not yet fully reflected in the cash bond market.

Despite the rapid growth in CDS activity, the FT report cautioned against interpreting higher premiums and trading volumes as evidence of an immediate threat to the creditworthiness of most major technology companies.

The market is increasingly being used to manage exposure to the financial risks associated with AI investment. As companies borrow more to build infrastructure, lenders and investors have greater incentives to protect themselves against a potential downturn in spending, weaker returns or deteriorating credit conditions.

The distinction is important. A rise in CDS demand may reflect caution about the future rather than a judgment that a company is likely to default.

Nevertheless, the expansion of the market highlights a change in how investors are approaching the AI boom. Equity investors have focused heavily on revenue growth, valuations and the commercial potential of artificial intelligence. Credit investors are increasingly examining the debt required to sustain that expansion and whether future cash flows will be sufficient to service it.

The growing CDS market does not establish that the AI investment cycle is approaching a collapse. It does, however, show that investors are paying closer attention to the financial risks beneath the sector’s rapid expansion.

Sources: Financial Times Alphaville, AI is making CDS great again; Financial Times, AI debt worries spark surge in default insurance trading; Barclays, credit derivatives market analysis cited by the Financial Times.