With technology companies preparing to borrow hundreds of billions of dollars to fund artificial intelligence investments, lenders and investors are increasingly focused on protecting themselves against potential failures, Bloomberg reported.

Banks and money managers are increasingly trading in derivatives that provide payouts if individual tech companies, known as hyperscalers, default on their debt. The cost of credit derivatives on Oracle bonds has doubled since September.

Meanwhile, trading volume for credit default swaps (CDS) linked to the company rose to approximately $4.2 billion over the six weeks ending 7 November, the report said, citing Barclays Plc credit strategist Jigar Patel. This is less than $200 million, compared to the same period last year.

“We’re seeing renewed interest from clients in single-name CDS discussions, which had waned in recent years,” John Servidea, global co-head of investment-grade finance at JPMorgan Chase & Co told the news agency. “Hyperscalers are highly rated, but they’ve really grown as borrowers and people have more exposure, so naturally there is more client dialogue on hedging,” Servidea said.

Traders noted that trading activity remains modest compared to the large volume of debt anticipated to enter the market. However, the increasing need for hedging suggests that technology firms are starting to exert significant influence over capital markets as they aim to transform the global economy through artificial intelligence.

Growing AI investments

JPMorgan strategists estimate that investment-grade companies might issue approximately $1.5 trillion in bonds in the next few years. Recently, several large bond offerings linked to AI have entered the market, such as Meta Platforms Inc.’s $30 billion note sale in late October- the largest corporate bond issuance in the US for the year- and Oracle’s $18 billion offering in September.

Tech companies, utilities, and other borrowers linked to AI now comprise the largest segment of the investment-grade market, the report said, citing JPMorgan. They have overtaken banks, which previously held the largest share. Additionally, junk bonds and other major debt markets are expected to experience a surge in borrowing as firms expand their data centre networks worldwide.

Banks are now among the largest buyers of single-name credit default swaps on tech companies, as their exposure to these companies has increased significantly in recent months.

What are the risks?

There is a need for money managers and lenders to consider reducing exposure now, the new portal noted, citing an MIT report that revealed that 95% of organisations see no return on investment from generative AI projects.

Although some of the largest borrowers now have high cash flows, the technology sector has historically been marked by rapid change. Companies like Digital Equipment Corp., once major players, can become obsolete over time, the report said. Bonds that appear safe today might become significantly riskier or even default in the future if, for instance, profits from data centres do not meet current expectations.

Before the financial crisis, the high-grade single-name credit derivatives market experienced higher volumes than now. Proprietary traders at banks, hedge funds, and bank loan managers, among others, used these products to reduce or increase their risk exposure.

After Lehman’s collapse, trading volume in single-name credit derivatives dropped, and market participants believe it’s unlikely to reach pre-crisis levels again. Currently, there are more hedging tools available, such as corporate bond exchange-traded funds, and credit markets have become more liquid due to increased electronic bond trading.