The General Office of the Central Committee of China’s Communist Party and the General Office of the State Council on July 24, 2021 jointly released the Opinions on Further Reducing the Burden of Homework and Off-Campus Training for Compulsory Education Students (the “Opinions”)1. The Opinions took immediate effect on the day of their release.
“Double Reduction” in the Opinions refers to a reduction in the total amount and time of commitment required by school homework and a reduction in the burden of off-campus or after-school training programs. Based on the Opinions, the Double Reduction policy is intended to improve the overall quality of school education, reduce excessive study burdens and protect the health of students, relieve the burdens and anxiety of parents, reduce social inequity, further regulate and standardize off-campus training (including both online and offline training), and strictly implement the Compulsory Education Law, the Protection of Minors Law and other laws and regulations governing the education industry.
While the Opinions set out various targets and requirements for in-school education, particular emphasis is placed on regulating after-school private-tutoring activities. Key developments include:
The “Double Reduction” policy has a significant impact on the private tutoring industry. Immediately after the promulgation of the Opinions, the stock prices of Chinese education companies listed in the US, Hong Kong and other overseas stock markets, including those of New Oriental Education, TAL Education Group, Gaotu Techedu and Scholar Education Group, plummeted.
Government intervention in the private tutoring industry came shortly after the launch by the Chinese government in early July of a cybersecurity investigation into several Chinese technology companies listed in the US, including Didi Chuxing, the country’s largest ride-hailing service, Yunmanman and Huochebang, China’s two leading truck-hailing apps, and Boss Zhipin, one of China’s largest online job recruiting platforms. The stock prices of these companies then plunged.
On July 30, in response to market reaction to China’s new policies on “China concept stocks” (CCS) listed in the U.S., the U.S. Securities and Exchange Commission (SEC) issued a public statement requiring that China-based operating companies listed in the US stock markets by using VIE structures make clearer disclosures relating to risks associated with the VIE structures and actions of Chinese government that could significantly affect the company’s financial performance, before their registration statements will be declared effective.2
With respect to the private tutoring industry, investors’ concerns center mainly around the legality of VIE structures, the requirement to convert “for-profit” training institutions into “non-profit organizations”, and the prohibition on foreign investments in “subject-based” training institutions.
In China, certain industrial sectors, including, without limitation, telecommunications value-added services, compulsory education, media, basic infrastructure, and certain other sectors which have a potential bearing on national security or the public interest, are restricted with respect to foreign investment or ownership. As a practical matter, many Chinese companies involved in these sectors have raised capital from overseas stock markets using VIE structures.
In a typical VIE structure, a holding company is established in an overseas jurisdiction (e.g., the Cayman Islands) to issues shares to overseas investors. The offshore holding company, through one or more wholly-owned subsidiaries in China, enters into a set of control agreements with a China-based operating company which is typically set up as a 100% Chinese-domestically-owned company in order to retain requisite operating licenses or approvals in industrial sectors for which foreign investment or ownership is restricted. As such, a VIE structure essentially allows the overseas holding company to exercise control over management, financing and operation of the China-based operating company through contractual arrangements even though the overseas holding company does not hold any equity in the China-based operating entity.
Although the VIE structure sits in a grey area of Chinese law, as a practical matter, the Chinese government has been reluctant to take actual enforcement actions against such structure in the two decades since Sina Corporation completed its IPO in the US using a VIE structure for the first time. Although the Opinions prohibit foreign investors from investing in “subject-based” training institutions through mergers and acquisitions or VIE structures, it does not necessarily mean that the government has changed its position on the VIE structure itself. Rather, the Opinions suggests that the Chinese government recognizes the VIE structure as one of the ways for foreign investors to invest in restricted sectors.
It is reported that in response to the market reaction to recent policy changes, the Chinese government (including the China Securities Regulatory Commission (CSRC)) has reached out to multinational investment banks, foreign chambers of commerce and other international corporations doing business in China on multiple occasions to reassure investors that China will continue to engage with global capital markets and will take into consideration the impact of regulatory policies on investors to public companies. As for the VIE structure, it is reported that the Chinese government views VIEs as a necessary and vital part of how Chinese firms engage with global markets. We remain reasonably confident that the government will continue to maintain the status quo of the policies on the VIE structure, at least in the near term, although the suddenness of regulatory restrictions on particular industries has increased investor caution.
With respect to the requirement to convert training institutions from “for-profit” organizations to “non-profit” organizations, we note that such requirement applies only to “subject-based” training institutions under the Opinions. For training institutions which are public companies with many foreign investors, it is unlikely that the government will rush any decision to enforce the “non-profit” requirement. Instead, training institutions will likely be required to restructure or transform their “subject-based” activities to “non-subject-based” activities in order to continue to be treated as “for-profit” organizations. For example, some training institutions have already started to spin off their “subject-based” businesses by establishing non-profit schools for such activities, in order to keep their other businesses as “for-profit” businesses. Another potential alternative is for training institutions to work closely with schools to offer extracurricular programs or provide ancillary services to assist the schools in “subject-based” education.
The Double Reduction policy will clearly bring a fundamental change to the regulatory landscape of the private tutoring industry. The Ministry of Education and local education authorities in different localities are in the process of formulating detailed rules to implement the Double Reduction policy. How the Double Reduction policy will be implemented remains to be seen.