Revision class – are there still opportunities for foreign investors in China education?

China's recent sweeping moves to ban off-campus for-profit after-school tutoring (AST) in school curriculum subjects for compulsory education grades (K-9) (Curriculum K-9 AST)¹ took investors in the US$120 billion industry by surprise and caused the valuations of some of the largest educational providers to plummet on global exchanges.

The Opinions for Further Easing the Burden of Excessive Homework and Off-campus Tutoring for Students at the Stage of Compulsory Education (Opinions) jointly issued by the General Office of the Central Committee of the Chinese Communist Party (CPC) and the General Office of the State Council, set out high level policy restrictions designed to improve the quality of education, ease homework burdens on students, alleviate financial pressures on parents and restrict both foreign and domestic private investment in the industry. Policymakers say the aim is to encourage a higher birth-rate, amidst indications of a demographic contraction.

The impact on off-campus tutoring providers has already been severe. On 26 July 2021, New Oriental Education Group, one of the latest private education providers in China, announced that the Opinions had been a huge blow to its business and the group would "follow the spirit of the Opinions and comply with relevant rules and regulations when providing educational services."

TAL Education Group, a NYSE listed AST provider, made a similar statement on 25 July 2021 announcing that "the Opinion, related rules and regulations, and the compliance measures to be taken by the Company will have material adverse impact on its after-school tutoring services related to academic subjects in China's compulsory education system, which in turn may adversely affect the Company's results of operations and prospect. The Company will proactively seek guidance from and cooperate with government authorities in connection with its efforts to comply with the Opinion and any related rules and regulations."

Policy restrictions

The Opinions target primarily Curriculum K-9 AST² and provide a number of high level policy restrictions aimed at substantially reforming this industry. We set out below the major policy restrictions.

AST centres

Local governments may no longer approve new Curriculum K-9 AST centres (and other provisions of the Opinions also indicate that they may no longer approve off-campus tutoring centres for pre-schoolers and curriculum subject tutoring centres for senior high school students). Existing Curriculum K-9 AST centres must re-register as non-profit institutions, and the price chargeable for their services will be subject to price guidelines to be issued by the government authorities. These fundamental changes to the business model will have a tremendous impact on existing players and make this industry significantly less attractive to investors (additionally, see below regarding the ban on foreign investment including through variable interest entity (VIE) structures).

Local governments are given additional powers to regulate online curriculum subject AST providers which must be assessed for re-approval according to the Opinions. Foreign education courses are banned and there is to be greater supervision of the tutoring materials used. There are new controls on the recruitment of foreign teachers and other staff. Firms may not recruit tutors based outside China, a blow to an industry which has relied heavily on online classes often hosted from overseas. Public advertising is forbidden, along with a ban on the placing of "hidden" advertisements in the form of stationery and uniforms.

In contrast, schools are instructed to offer online learning services, developing new free-to-use online learning platforms, and improve on-campus offline after-school services.

Online tutoring and offline "advance" curriculum subject tutoring for pre-schoolers are prohibited (only offline non-curriculum subject tutoring seems to be permitted for pre-schoolers).

Scheduling

The Opinions prohibit curriculum subject tutoring on public holidays, weekends and during winter and summer holidays, traditionally busy periods for off-campus education. Lessons conducted online must be no longer than 30 minutes and there must be at least 10 minutes between lessons which should end by 9:00 p.m.

Schools are instructed not to assign homework to students in grades one and two and aim for an average of 90 minutes homework for students in junior high school.

Schools should encourage students to sign up for after-school programmes to be run by teachers, retired teachers, social workers, and volunteers. Parents are encouraged to communicate with their children and restrict the use of mobile devices.

Private investment

Existing curriculum subject AST centres may not raise equity finance by way of public offerings or carry out "capitalization operations" (a term that is not defined in the Opinions, introducing considerable uncertainty). The Opinions prohibit the acquisition of equity interests by foreign investors in curriculum subject AST centres, whether through mergers and acquisitions, entrusted operation, franchising, or by using VIE structures.

VIEs are widely used in China in a variety of different industry sectors and they have become the method of choice for listing Chinese companies on foreign stock exchanges. Until the changes, many education businesses on the mainland had been able to raise offshore capital by using VIE structures, circumventing restrictions on foreign investment put in place in the Negative Lists (i.e., the Special Administrative Measures (Negative List Edition 2020) on Access to Foreign Investment, the Free Trade Zone Special Administrative Measures (Negative List Edition 2020) on Access to Foreign Investment, and the Hainan Free Trade Port Special Administrative Measures (Negative List Edition 2020) on Access to Foreign Investment).

The Opinions – and the Implementing Rules for the Law for Promoting Private Education published by the State Council on 14 May 2021 and coming into effect on 1 September 2021 (Private Education Law Implementing Rules) – make clear this is no longer an option. Those tutoring companies and private schools which operate under a VIE structure will need to quickly adapt to the new environment.

The Opinions also prohibit listed companies from investing in curriculum subject AST providers with funds raised on the stock market and from purchasing their assets against the payment of cash or issuance of shares.

In Shenzhen – often held out as a "model city" pointing the way towards future national development – the government issued draft Regulations on Preschool Education in the Shenzhen Special Economic Zone on 15 July 2021 which also ban private kindergartens from seeking public listings.

Private Education Law Implementing Rules

The Opinions come just weeks after China published the Private Education Law Implementing Rules setting out new restrictions on private schools. The Opinions and the Private Education Law Implementing Rules regulate different issues (AST vs. private schools) but they are both part of the overall reform of the private education sector launched by the Chinese government.

 In particular, the Private Education Law Implementing Rules set out the following restrictions:

• Article 5 prohibits foreign-invested enterprises from establishing or operating compulsory education schools.
• Article 7 prohibits public schools from engaging in the establishment of private schools.
• Article 13 prohibits any entity or person other than the school's sponsor registered on the school's license from controlling private schools that provide compulsory education or non-for-profit private schools that provide pre-school education, by means such as mergers and acquisitions, contractual control arrangements, etc..
• Article 26 decrees that the board of directors of any private school offering compulsory education must consist solely of Chinese nationals.
• Article 29 prohibits private schools that teach the compulsory syllabus from using foreign teaching materials.

The Chinese government is taking action to organize the implementation of the Private Education Law Implementing Rules. China's Ministry of Education and seven other governmental departments recently issued the Circular on Regulating the Organization or Participation in the Organization by Public Schools of Private Compulsory Education Schools on 19 July 2021, providing directives to local governments on the implementation of the Private Education Law Implementing Rules and requiring the private schools set up by public schools independently or together with other parties to be converted into public schools, unless the private schools can meet certain independent principles after the public school withdraws.

Significance and enforceability of the Opinions

The Opinions are an administrative regulatory document with general binding force. However, their content is quite general and may not be directly enforceable in practice in the absence of implementing legislation. It is unclear purely based on the letter of the Opinions how compliance with certain requirements set out in the Opinions has to be achieved.

The Opinions also provide that companies operating in violation of certain requirements set out in the Opinions must be "rectified" (without providing any details as to how such "rectification" is meant to be achieved). As we await additional implementing measures to be issued, companies should begin to reflect on how to achieve compliance with the Opinions and seek guidance proactively from government authorities.

Article 23 of the Opinions provides that pilot programs implementing the Opinions will initially be carried out in nine cities (Beijing, Shanghai, Shenyang, Guangzhou, Chengdu, Zhengzhou, Changzhi, Weihai, and Nantong), focusing primarily on reducing the number of curriculum subject AST providers, utilizing the schools' own resources to organize extracurricular activities, and strengthening the regulation of tutoring fees. Some of these pilot cities have already promulgated measures to implement certain aspects of the pilot program, and it is expected that additional measures will be released shortly.

Remaining opportunities for foreign investors in the education sector

The Opinions, and the additional implementing legislation that is expected to be issued, will have a profound impact on the development of the AST business in China, severely restrict the operations of companies currently engaging in this business, and substantially shut this market to new entrants.

One area in which foreign investment is still permitted without any foreign ownership restrictions is that of vocational education, a sector where foreign investment is encouraged under the Catalogue of Encouraged Industries for Foreign Investment (2020 Version). Foreign investment in non-curricular AST (such as sports, music, art, computer programming) (whether K-9 or above) is generally permitted, as the restrictions on foreign investment set out in the Opinions focus on curricular AST.

Foreign investment is permitted but subject to foreign investment restrictions in other sectors of the education industry (for example, foreign investors can invest in pre-schools/kindergartens, senior high schools and universities in the form of cooperative education institutions established with a Chinese partner in which the Chinese partner holds a controlling stake, and the sector is being further liberalized in the Hainan Free Trade Port – a recently established free trade zone encompassing the whole of Hainan Province).

It is not all over for foreign investors in China's educational space, however they need to ensure that they keep up-to-date and informed on China's shifting policy goals. Stakeholders will need to seek guidance proactively from government authorities and cooperate with them to ensure they comply with the Opinions, the Private Education Law Implementing Rules, and any related rules and regulations.

Authored by Sherry Gong, Jonathan Leitch, Aldo Boni de Nobili, and Nigel Sharman.

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To know more about recent legal developments that impact China's educational system, read Sherry Gong's article for the National Association of College and University Attorneys (NACUA) Doing Education Business in China highlighting key Chinese laws that apply to higher education institutions in the areas of tax, intellectual property, research, student recruitment, immigration, cybersecurity, and online programs.