A report released today by the Bank for International Settlements (BIS) provides some of the most detailed information to date about how credit default swaps (CDS) transfer credit risk between different institutions.
The BIS report shows that CDS dealers on net bought protection from all other types of counterparties except for hedge funds. When it comes to hedge funds, CDS dealers are not only net protection sellers, but from June 2010 to June 2011 hedge funds about doubled their protection buying from dealers to over $300 billion. This is shown by two panels from Graph 1 of the report, which is entitled "Net credit protection bought by reporting dealers from different counterparty groups":
Accordingly, in the past year or so hedge funds have been using CDSs to express increasingly bearish views on debt markets, which the report indicates primarily relate to sovereign and (non-financial) corporate debt. And because these graphs show that dealers are net long in their CDS positions, hedge funds' CDS shorts are probably ultimately being absorbed by the other categories of counterparties.
My own working paper on the broader topic of credit risk transfer governance is available here.