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As big tech companies raise hundreds of billions of dollars to fund artificial intelligence investments, Wall Street banks are increasingly finding they have to trade more credit derivatives to keep doing business with the hyperscalers.<\/p>\n
The surge in activity is creating an opportunity for hedge funds to profit from banks\u2019 growing demand for these instruments.<\/p>\n
Banks typically face limits on how much exposure they can have to a single company across loan portfolios and derivatives books. But so-called hyperscalers such as Meta Platforms Inc. and Alphabet Inc. are raising so much capital to fund their artificial-intelligence programs \u2014 they are estimated already to have borrowed more than $250 billion globally for AI \u2014 that banks may be starting to approach those limits.<\/p>\n
That\u2019s where credit derivatives come in: they let banks buy protection against a company defaulting on debt, reducing their exposure to a borrower. They can then lend the firm more, underwrite its debt and trade derivatives with it.<\/p>\n
Banks are constantly buying and selling credit derivatives tied to hyperscalers as their exposure shifts. But they are generally purchasing protection, because the derivatives give them the capacity to win more lucrative fee business. Their demand has driven up the cost of protection on hyperscalers to unusually high levels relative to their credit ratings. And hedge funds are looking to profit by selling that protection that can look overpriced.<\/p>\n
\u201cIt\u2019s the best opportunity in AA credit default swaps in a very long time,\u201d said Andrew Weinberg, portfolio manager at Saba Capital Management, referring to the opportunity to sell protection on highly rated hyperscalers at prices typically seen for smaller, lower rated companies. \u201cYou are dealing with an inefficient market.\u201d<\/p>\n
Take Meta credit default swaps. Five-year contracts traded on Friday at about 0.73 percentage point annually, meaning a hedge fund selling protection on $10 million of principal can collect $73,000. There\u2019s relatively little risk: Meta is graded AA- by S&P Global Ratings and Aa3 by Moody\u2019s Ratings, the fourth-highest level.<\/p>\n
It\u2019s far more lucrative than selling CDS tied to companies in the broader North American investment-grade index. Five-year default protection on $10 million of the index cost about $52,000 annually, and the index\u2019s average rating is about BBB+, or four notches lower than Meta. Selling Meta CDS therefore can generate significantly higher returns with higher rated credit.<\/p>\n
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Wall Street dealers that facilitate such trades say much of the demand for hyperscaler CDS is coming from banks\u2019 credit valuation adjustment \u2014 or CVA \u2014 desks, which manage hedging arrangements.<\/p>\n
Bank of America Corp. is among the dealers seeing a surge in activity. Monthly notional volumes of hyperscaler CDS trading at the bank are up tenfold since the beginning of 2025, according to Matt Mandell, BofA\u2019s head of US single-name CDS.<\/p>\n
\u201cInvestors continue to look to buy hyperscaler CDS, and a lot of that does come from the CVA desks,\u201d Mandell said in an interview. \u201cThey\u2019re trying to avoid being constrained by credit limits.\u201d<\/p>\n
Bank demand is driving up prices for hyperscaler CDS, and pushing trading volumes to record highs.<\/p>\n
CDS tied to Microsoft Corp., Amazon.com Inc. and Oracle Corp. notched $4.6 billion in notional trading volume in the first quarter, from $759 million a year earlier, according to Depository Trust & Clearing Corp. Meta CDS \u2014 only launched last October \u2014 had $534 million in notional trades, more than double the prior quarter. The figures likely understate activity because DTCC caps individual reported trades at $5 million.<\/p>\n<\/p>\n
CDS contracts for some hyperscalers didn\u2019t trade actively until last year, when the companies ramped up their borrowing to fund more AI investments. With the artificial intelligence buildout projected to cost $5 trillion through 2030, CDS-selling hedge funds may have plenty more scope to profit.<\/p>\n
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For one, the debt spree is going global, with hyperscalers increasingly borrowing in currencies including euro, sterling and yen. That often forces CVA desks to buy more CDS, as companies often hedge foreign-currency exposure back to dollars through cross-currency swaps with banks. CDS can also help CVA desks hedge indirect exposure to data center deals and loans backed by graphics processing units.<\/p>\n
\u201cBanks are buying CDS to open up their credit lines, allowing them to trade and lend even more with hyperscalers,\u201d Bofa\u2019s Mandell said.<\/p>\n
Demand is coming from other places too. Mandell is seeing more equity investors buy hyperscaler CDS as a cost-effective way to hedge stock positions. Asset managers and private credit funds are trading CDS on the companies as well.<\/p>\n
Meanwhile, S&P Dow Jones Indices has added Meta, Alphabet and Microsoft to its CDX Investment-Grade Index, and JPMorgan Chase & Co. recently introduced a CDS basket that traders can use to bet against five hyperscalers\u2019 debt.<\/p>\n
Morgan Stanley strategists Vishwas Patkar and Joyce Jiang say there\u2019s good risk-reward in buying protection on hyperscalers versus the broader investment-grade CDX index. While accepting that big tech firms are exceptionally high-quality, they say surging debt supply is concentrating exposure across a small set of issuers.<\/p>\n
\u201cQuality deterioration remains a risk,\u201d they wrote in a note. \u201cWe like funding these shorts by selling protection on the broader index, which has less exposure to technology names.\u201d<\/p>\n
\u00a9 2026 Bloomberg<\/p>\n
#Hyperscaler #debt #flood #brings #derivatives #bonanza<\/p>\n","protected":false},"excerpt":{"rendered":"
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