The monoline financial guarantor business was established in the early 1970s in the United States in response to a series of high profile municipal bond defaults. The U.S. municipal bond market was and remains a largely retail market and retail investors do not generally have the ability to analyse the risks presented by the issuers, requiring them to rely upon public ratings from rating agencies such as Standard & Poor's and Moody's Investor Service.
Historically, the monolines' basic business model was to issue unconditional and irrevocable guarantees of timely payment of principal and interest to investors while maintaining a sufficient capital base against those guarantees to achieve triple-A ratings. The amount of capital required for each guarantee issued is determined by reference to rating agency models of default probability and expected loss given default on the underlying securities. The issuer's security would benefit from the triple-A rating of the monoline rather than its own rating, thereby producing a lower cost of funds. This saving is shared with the mono-line in the form of a fee from the issuer to the monoline for issuing the guarantee ("wrapping" the bond). This model is heavily dependent on the ability of the monoline to maintain a rating that is, if not triple-A, then at least sufficiently high to produce value when the guarantee is issued against the securities of most potential borrowers.
In the mid-1980s, the monolines began to extend guarantees on financial instruments outside the munici-pal bond sector, most notably in respect of asset-backed securities derived from consumer loan products such as residential mortgages and automobile loans. The companies arrived in Europe in the late 1980s and became key players in the PPP financing markets from the late 1990s. Monoline-guaranteed instru-ments have been used to finance PPP projects in a number of European countries, but the monolines' greatest impact was in the United Kingdom because of the combination of the government's extensive Private Finance Initiative scheme and the presence of a deep and liquid bond market which provided a competitive alternative to bank financing of these projects. The dominance of the wrapped bond execution in the UK is illustrated by the fact that from 1997, when the first PPP project financed through the capital markets was closed, through today, only two early projects were funded with bonds that did not bear a monoline guarantee. The effect of this reliance on the monoline to achieve a capital markets execution is discussed below.