[Maurice]

Outstanding notional of CDS is nowhere near 500T, the previous poster's sources were probably confusing CDS with interest rate swaps (which form the lion's share of derivatives contracts by notional value). I'd put total CDS notional at more like 50T.

These are mostly sold by top-tier investment banks. JPMorgan is the leader in the market. The big banks have lots of positions in these, but tend to manage the risk pretty flat - i.e. they'll be long default risk with one counterparty and short default risk with another, more or less netting out.

That's not to say there isn't any systemic risk in this market, I think there could be.

Another interesting issue arises from the fact that these contracts are usually physically settled - meaning if I sell you a CDS on reference entity X and X goes under, I owe you the notional value of the contract and you owe me that same (face) value of bonds. (since the bonds almost always have some value even in bankruptcy).

What happens if there are more CDS outstanding on a given name than bonds? It could be physically impossible for all the CDS buyers to obtain bonds in the market, thus many will be unable to meet their obligations under their existing contracts.