26 November 2019

China Tightens Regulation for Online Education

This article was written by Mark Schaub, Iris Feng and Serena Guo

The past five years witnessed a boom in the online education sector in China with annual revenues increasing from RMB 122.54 billion in 2015 to RMB 269.26 billion (forecast) in 2019[1]. The rapid expansion is attributable to  consumers’ love of the internet, the continued growth of the middle class combined with the high regard in which education is held in China.   

However, the online education regulatory regime has not matched the sector’s speedy development. The regulations remain fragmented and spread across a variety of regulations that govern online activities more generally. 

Curiously for a business that combines two highly sensitive areas of the Chinese economy – the internet and education - online education was only first officially addressed in 2018.

To some extent the PRC regulators are catching up as they have issued a slew of regulations in order to better regulate online education. The regulations acknowledge the hybrid nature of online education as a number of different authorities are cooperating in building the regulatory framework.

General overview

The first regulation officially addressing online education is the Opinion on Regulating After-school Training Institutions (“Opinion 80”) issued by the State Council in August 2018. Opinion 80 requires governmental agencies in telecommunications, culture, industry and information and broadcasting sectors to cooperate with education regulators in respect of online education.

Since the issuance of Opinion 80 the PRC regulators have published 5 regulations/rules (including one draft regulation) aimed at regulating and guiding the development of online education in China. 

The intention to tighten controls on online education is most clearly seen in the Draft Regulation on the Implementation of the Private Education Promotion Law of the People’s Republic China (“Draft Private Education Regulation”) that was issued for public comments in August 2018. The Draft Private Education Regulation requires that in addition to internet-related licenses, online education institutions will also be required to obtain private school permits or make filings with competent education authorities, depending on if their online education activities are related to diploma education. However, it should be noted that the Draft Private Education Regulation has not been adopted to date and it remains unclear whether the above provisions will even come into force.

The other regulations that impact online education include:

#

Date of issue

Regulations

Main requirements

1

November 20, 2018

Notice on Improving Working Mechanisms Special Rectification of After-school Training institutions (“Circular 10”)

  • After-school online training institutions should complete filings in respect of curriculum
  • Provincial education authority to cooperate with telecommunication authorities to strengthen the regulation on online education content

2

December 25, 2018

Notice on the Prohibition of Harmful APPs from Entering Primary and Secondary School (“Circular 102”)

  • Learning apps targeting primary and secondary schools (“In-school Apps”) must complete filing before being used in schools
  • Schools are required to establish “Double Check Systems” to ensure In-School Apps are properly scrutinized

3

July 12, 2019

Implementation Opinion regarding Regulating After School Online Tutoring ("Opinion 8”)

  • After-school online tutoring activities targeting primary and secondary school students need to have details as to content and teachers filed with the authorities
  • Black and white lists will be set up to regulate online tutoring

4

August 10, 2019

Opinion on Guiding and Regulating the Development of Educational Mobile Internet Apps (“Opinion 55”)

  • Providers of Educational Mobile Internet Apps are required to make filings with the provincial education authorities after the ICP filing /license is obtained
  • The definition of “Educational Mobile Internet Apps” is very broad and covers all mobile apps used by teachers, students or parents in an educational setting

The filing requirements for online training activities (including those conducted via an App) are already effective and requires existing players in the online education market to comply.

As outlined above – the authorities have recognized that online education crosses over a number of areas of competencies and therefore requires coordination and cooperation amongst regulators. This is emphasized by both Opinion 80 and Opinion 55 as online education touches upon both education and the internet.

Can foreign companies invest in online education in China?

As expected, there is no simple answer for the foreign investment in the online education in China.

The No.1 rule is to avoid investment in online activities that provide compulsory education, including primary education and junior high school education. Foreign investment in compulsory education is expressly prohibited under the Special Administrative Measures for Foreign Investment (amended in 2019).

The level of foreign investment regulation will depend upon the activities in which its Chinese subsidiary engages in.

In addition to the school filing which needs to be obtained from the local education authorities, the foreign invested Chinese subsidiary may need to obtain additional licenses or permits from other regulators before it will be able to operate its business. As will be seen from the below table in most cases such licenses will not be obtainable:  

Licenses

Activities requiring such licenses

Obtainable by foreign invested enterprises

ICP License

If the online education/training is commercial in nature.

Challenging (maximum foreign shareholding is 50%)

Permit for Production and Operation of Radio and TV Programs

If the platform produces or transmits radio or television programming. 

Not possible

License for Online Transmission of Audio-Visual Programs

If the platform provides its own video content to students and students can upload and disseminate videos

Not possible

Internet Culture Operation License

If the platform undertakes commercial internet-based cultural activities in China (including commercial online performance activities).

Not possible

Online Publication License

If platform distributes and publicizes online teaching materials or audio-video products or other publications to students online 

Not possible


If you cannot do much legally then what is the reality?

Despite the rigid regulations outlined above there are many large education companies that are very active in online education in China.

Some have operated an offshore model, but most have adopted a VIE model.

The VIE model is where a foreign company arranges for domestically incorporated entities to be held by nominees and which are controlled by the foreign company by means of contractual arrangements. Under a VIE structure, the “controlled” domestic company obtains the requisite licenses to operate the business. The contractual arrangements typically include exclusive service agreements which allow the finances of both entities to be consolidated under GAAP accounting rules.

VIE structures are also used by foreign investors who wish to circumvent restrictions on operating in China in restricted or prohibited sectors (such as online, education and online education!).

It has long been considered that VIE structure is a “grey” area of Chinese law as it has never been tacitly approved by the PRC authorities and there have been some cases where the domestic company decided to not fulfil its obligations under the contractual arrangement and when taken to court it was ruled that such contractual arrangements were unenforceable as they were intended to circumvent PRC regulatory requirements.

Examples of large education companies using a VIE approach include HK and New York listed companies.

Operator

Main Services

Key Licenses held by VIE

Remarks

Company A[2]

  • Online education for pre-school students; 
  • ICP license
  • Publication Operation License
  • Internet Culture Operation License
  • License for Online Transmission of Audio-Visual Programs
  • No online education filing was made at time of IPO

Company B[3]

  • Online courses, including K12 after-school tutoring and foreign language courses etc;

  • Interactive learning apps;
  • ICP license
  • It claimed in its disclosure other licenses are not required for its operation

  • No online education filing was made at time of IPO 

Company C [4]

  • Online K12 tutoring courses across all primary and secondary grads
  • ICP license
  • It claimed in its disclosure other licenses are not required for its operation

  • No online education filing was made at time of IPO

Most of the companies do not hold the necessary operating licenses we mentioned above even though they are listed.

Accordingly, it seems that the relevant regulations in respect of online education are not being strictly enforced and a grey area remains. However, there is a risk that trend to increasing regulation will not doubt be of concern to such companies. In particular, it should be noted that the Draft Private Education Regulation explicitly bans VIE models in respect of compulsory education.

Offshore model

As online education touches upon both internet and education, two equally sensitive and highly restricted sectors in China, some foreign investors eschew the option of establishing a foreign-invested enterprise in China as it will not be able to obtain most of the operational licenses required to be compliant. As an alternative, some companies are operating a “purely” offshore model to distribute online education services to Chinese students.  

From a practical perspective, it is difficult for the PRC government to exert any substantial supervision over a website whose servers are situated outside of China.

However, the offshore model does still face restrictions under PRC law in respect of interaction with Chinese consumers; issues with transfer of funds out of China; invoicing; permanent establishment risk, privacy etc.


[1] https://www.statista.com/statistics/739487/china-online-education-market-size/.

[2] Listed in HK Stock Exchange in March 2019.

[3] Listed in New York Exchange in October 2019.

[4]  Listed in New York Exchange in June 2019.


[3]
[3]

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