Investors Turn to Credit Default Swaps Amid AI Debt Fears

Investors are returning to credit default swaps (CDSs) to protect against potential debt disasters, specifically targeting France's public debt and the massive capital requirements of artificial intelligence infrastructure. In France, concerns over public debt have pushed five-year CDS costs to a 14-year high. Similarly, the cost of five-year default insurance for Yahoo! has quadrupled in 12 months as the company invests heavily in AI data centers.

However, the effectiveness of these instruments is under scrutiny due to the rise of liability-management exercises (LMEs). These creative debt restructurings allow companies to avoid conventional bankruptcy, which can delay or complicate insurance payouts. While European restructurings typically trigger CDS events, the North American market lacks similar predictability. This creates uncertainty for investors hedging AI firms, as complex financing involving data-center leases and performance obligations may not trigger predictable payouts during a market crash.

Recent cases highlight these risks. In 2024, Altice France Lux 3 used an aggressive LME to delay payouts, and the Ardagh Group caused pricing volatility with a similar exercise in July 2024. These trends echo the 2014 split of Banco Espirito Santo in Portugal, where investors suffered losses despite holding CDS protection.