The Chinese education sector is one of the service industries many investors, both foreign and domestic, see as particularly promising. Meanwhile, education in China has seen an increasing trend to tighten regulation and supervision of investors and operators over the last two or three years. In response to such tighter regulation, in particular the prohibition for foreign investors to directly invest into Chinese compulsory education of grades 1 to 9, arguably the most attractive part for investors, the market has mainly adopted contractual arrangements of different kinds to link up with Chinese partners, establish a certain degree of control over the business and extract profits from it. While these schools are therefore Chinese private schools, either profit-making or not-for-profit, they appear and act on the education market as foreign schools. This practice has been widely adopted by school operators and investors and tolerated by the government authorities, but doubts have always remained whether these arrangements will last in the overall environment of an increasingly ideological education environment.
When the Ministry of Justice published the Circular seeking public comments on the Implementing Regulations of the Law of the People's Republic of China on the Promotion of Private Education (Revised Draft) (Draft for Review) (the "Draft") on 10 August 2018 concerns were high that the rules may be further tightened for the education business and its foreign investors. The Draft proposes a number of amendments to the prevailing version of Implementing Regulations of the Law of the People's Republic of China on the Promotion of Private Education. In the following we try to provide an overview of the changes and an evaluation of the likely impact.
The first point to make is that these are only a draft and do not yet have any legal impact.
It is possible that no final draft is ever produced, or is produced with further substantial changes – something that is not uncommon in China. However, as the draft reflects an increasingly ideological approach in central government and a desire to prevent not-for-profit schools being controlled by for profit organisations that is perhaps unlikely. It is also important to appreciate that the Draft is not focused solely at foreign investors in education in China.
In short the proposed changes are yet again trying to prevent operators in the educational sector avoiding the need to comply with existing regulations. In particular they are seeking to re-enforce the separation of for profit and not-for-profit schools in China and prevent foreign companies indirectly controlling schools in China. As a result, when they come into force, they may require Chinese partners operating schools in China under the name of a UK school to restructure themselves in order to remain in compliance with Chinese law.
A number of questions in relation to the Draft remain unclear, such as the key terms "Education Group" or "contractual control". Without respective clarifications the exact impact of these new rules is difficult to predict, but it is clear that the Draft constitutes a further tightening of the regulatory landscape for education businesses and their investors in China. High Level Analysis of the Draft
The main changes and our comments are as follows:
1. Restrictions on VIE arrangement and Foreign Investment in Compulsory Education
Article 5 of the Draft provides that foreign investment enterprises established in China and social organizations with foreign actual controllers may not sponsor, participate in sponsoring or actually control privately-run schools which provide compulsory education.
The restriction on foreign "control" over private-run schools comes from the prohibition of foreign investment in compulsory education as provided under the Foreign Investment Special Administrative Measures for Access of Foreign Investments (2018 Version). In order to "circumvent" this prohibition in China, the so-called “VIE Structure” is widely used by many overseas (particularly Hong Kong) companies. In a VIE Structure, domestic enterprises running an education business in China are controlled by overseas companies through various commercial contracts, such as management and consultancy agreements, call option agreements, equity pledge agreements and powers of attorney. Various Chinese education companies listed in Hong Kong have adopted the VIE Structure to conduct education business involved with compulsory education policies in China. The use of VIE Structures in the compulsory education sector has always been somewhat suspect, so this change should not be any great surprise.If the draft leads to the prohibition being extended to schools that provides non-compulsory education (i.e. pre-school, senior high-school and universities) that would be a substantial change to the current status quo, but nothing in the current Draft suggests this.
2. Education Groups cannot control Non-profit Private Schools
Article 12 of the Draft provides that "Education Groups" may not control not-for-profit private schools through merger and acquisition, franchising and contractual control.
The purpose of this provision is to avoid companies making profits from not-for-profit schools through an intra-group transaction. The Draft is rather vague and does not define "Education Groups". However, the State Education Bureau stated in its opinion that "Education Groups" mean that there is one sponsor which operates more than one private school. It is not clear whether the definition of "Education Group" will be further extended to include any sponsor controlling, controlled by, or under common control with that party who operates more than one private school, i.e. looking at indirect shareholding structures as well. It is also unclear whether having the same brand, under common teaching systems or sharing same course materials will be considered as "Education Groups". This clause may result in some Chinese partners of international schools need to restructure their businesses in order to comply with the regulations, e.g. by establishing more complex holding structures or the like.
3. Public Schools may not Sponsor or Participate in Private Schools Unless Approved
Article 7 provides that:
(a) public schools shall not participate or sponsor private schools;
(b) public schools who wish to participate or sponsor private schools requires approval by the government;
(c) public schools cannot make profit for licensing its name to the private school;
(d) public schools who are allowed by the government to participate or sponsor in private schools shall have separate teaching system, teaching staff, financial accounts; recruit students separately and issue certificates separately.
We believe that item (c) means that public schools should not simply license their name to private schools, although it may license its IP (along with its school name/brand), teaching resources, and management resources to the private school if it obtains applicable approval by the education bureau. The alternative interpretation, that any licensing of a school name is not permitted, would have a major impact on some of the school projects.
4. Affiliated Transaction is Supervised by the Government
Article 44 provides that fees, tuitions and other income payments generated from activities by not-for-profit private schools must be carried out under the bank account filed with the applicable education bureau. Schools are also required to build affiliated transaction information disclosure systems, publicize affiliated transactions, and ensure that any member of their board who has an interest in the affiliated transaction withdraws from voting. Article 45 provides that the Education Bureau or the Human Resources Bureau shall review and examine affiliated transactions entered into by the not-for-profit private schools and its affiliated parties.
In the past, many school sponsors have enjoyed preferential policies of not-for-profit private schools and then transferred the profits to the schools' affiliated entity. The Draft entitles the government to supervise and review transactions among affiliated parties of the non-profit school. It means that financial arrangements of schools become transparent for the government as the bank accounts of schools can be monitored anytime.
5. Classification of Permit
The Draft detailed the approval authority who issues permits to schools:
(a) Pre-school, and primary and middle school - approval by the Education Bureau in the district level;
(b) Universities - approval by the State Education Bureau or the Provincial level;
(c) Vocational training institution – approval by the human resources bureau in the district level;
(d) Institutions that provides tutorial for kids which supplements or relates to the courses taken at school or relates to cultures – approval by the education bureau in the district level;
(e) Institution that provides training of language, art, athletics, science for kids, and those that are improving kids' personality development and that provides culture related courses to adults - no approval is required but only need to obtain business license.
Additionally, the Draft also regulates online teachings:
- Online degree teaching - ICP license and subject to the above approval where applicable;
- Online non-degree vocational/training institution - ICP license and file with applicable education bureau and human resources bureau in the provincial level.
Most of the approval procedures and level of authority have existed for some time. The online related clarifications are interesting and seem to respond to the sky-rocketing online offerings for education in general. It is worth noting that provision of vocational training offline requires approval but the same business done online only requires filing. In practice, definitions in (d) and (e) are vague and leave much room for interpretation to the regulators. It therefore leads to uncertainty whether provision of services as described under (d) or (e) requires approval or not.
6. Preferential Policies for Non-Profit Private School
The Draft sets forth a set of preferential policies which may be offered to not-for-profit private schools:
- The government may allocate certain funds to reimburse not-for-profit private schools;
- The State shall lease or transfer available state assets to not-for-profit private schools in priority;
- Not-for-profit private schools should enjoy same policies as public school, such as land-use fees; and tax policies, etc.
This is merely a re-statement of existing regulations.