NEW YORK: As big tech companies raise hundreds of billions of dollars to fund artificial intelligence (AI) investments, Wall Street banks are increasingly finding they have to trade more credit derivatives to keep doing business with the hyperscalers.
The surge in activity is creating an opportunity for hedge funds to profit from banks’ growing demand for these instruments.
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 AI programmes – they are estimated already to have borrowed more than US$250bil globally for AI – that banks may be starting to approach those limits.
That’s 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.
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.
“It’s the best opportunity in AA credit default swaps (CDS) in a very long time,” 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.
“You are dealing with an inefficient market.”
Take Meta CDS. Five-year contracts traded last Friday at about 0.73 percentage points annually, meaning a hedge fund selling protection on US$10mil of principal can collect US$73,000. There’s relatively little risk: Meta is graded AA- by S&P Global Ratings and Aa3 by Moody’s Ratings, the fourth-highest level.
It’s far more lucrative than selling CDS tied to companies in the broader North American investment-grade index. Five-year default protection on US$10mil of the index cost about US$52,000 annually, and the index’s average rating is about BBB+, or four notches lower than Meta.
Selling Meta CDS, therefore, can generate significantly higher returns with higher rated credit.
Wall Street dealers that facilitate such trades say much of the demand for hyperscaler CDS is coming from banks’ credit valuation adjustment (CVA) desks, which manage hedging arrangements.
Bank of America Corp (BofA) 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’s head of US singlename CDS. “Investors continue to look to buy hyperscaler CDS, and a lot of that does come from the CVA desks,” Mandell said in an interview. “They’re trying to avoid being constrained by credit limits.”
Bank demand is driving up prices for hyperscaler CDS, and pushing trading volumes to record highs.
CDS tied to Microsoft Corp, Amazon.com Inc and Oracle Corp notched US$4.6bil in notional trading volume in the first quarter, from US$759mil a year earlier, according to Depository Trust & Clearing Corp (DTCC). Meta CDS – only launched last October – had US$534mil in notional trades, more than double the prior quarter.
The figures likely understate activity because DTCC caps individual reported trades at US$5mil.
With the AI buildout projected to cost US$5 trillion through 2030, CDS-selling hedge funds may have plenty more scope to profit.
For one, the debt spree is going global, with hyperscalers increasingly borrowing in currencies including the 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 centre deals and loans backed by graphics processing units.
“Banks are buying CDS to open up their credit lines, allowing them to trade and lend even more with hyperscalers,” Mandell said. — Bloomberg
