China’s new private education law pulls schools out of legal grey zone

January 17, 2017

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The Chinese private education sector has been booming. The number of private schools nearly doubled between 2005 and 2015 from 86,000 to 163,000, according to the Ministry of Education. However, the legal designation for all of China’s private schools has always been non-profit, as profit-seeking education entities were not legally allowed. The amendment to China’s law governing private education passed in early November 2016 has now made profit-seeking schools legally allowed in China for the first time. The opportunity for education organizations to legally operate profit-seeking schools for the first time is just one of the opportunities these regulatory changes pose.

On November 7th, China’s National People’s Congress passed an amendment to the “Promotion of Private Education Law”, which will come into effect on September 1, 2017. According to the the amendment, private schools shall be categorized as non-profit and for-profit and the two types of private schools shall be regulated separately. This is big news for private education organizations in China. The law allows private schools, excluding schools that offer “compulsory education” such as private primary schools and middle schools, to designate themselves as for-profit entities. Under the revised regulations, these newly legal profit-seeking schools will realize a few specific benefits:

Full autonomy in tuition fee setting

For-profit schools will have full autonomy in setting their tuition fees without any intervention from the government. Before the amendment, the government had to be informed about any tuition fee changes or approve them in some cases. This is particularly welcome news for some high-end private schools that want to further differentiate themselves in the market.

Stronger protection for asset ownership

As for-profit private schools will be subject to the corporate law, which protects the assets of business owners, for-profit school owners will be able to own the school assets legally after paying taxes. Before the amendment was passed, private school owners had no right to dispose of school assets once schools stopped running.

Going public without legal barriers

Before the amendment was passed, it was extremely difficult for private schools to have access to the financial market due to various restrictions imposed on non-profit schools. In order to bypass the restrictions, some private schools had to list themselves in overseas markets and transfer the profits to their overseas investors through financial vehicles such as “Variable Interest Entities” (VIE). However, going forward the longstanding legal barriers to go public will be lifted. Shareholders of the for-profit schools will now be able to obtain dividends legally. Many private schools are expected to be listed on the domestic stock market as a result of these regulatory changes.

Both for-profit and non-profit schools will face challenges and risks from the new law

Although there are clear benefits for private school operators resulting from this new amendment, some legal barriers may persist for private schools that offer both compulsory and non-compulsory education, such as schools that offer classes from grade 1-12. If they would like to go public, they would have to separate their for-profit and non-profit units and list only the entities offering education that is legally allow to be for-profit, such as pre-K or grades 9-12.

Another likely negative impact on profit-seeking schools will be the loss of preferential policies that private non-profit schools have long enjoyed. Many private non-profit schools have been receiving government subsidies in the form of cheap land or tax benefits. Although it is up to local jurisdictions to implement the law, and the details of the implementation laws have yet to be released, it is expected that for-profit schools would see government subsidies and other incentives reduced. Many schools, once they designate themselves as for-profit, may face abrupt cost increases, which will impact their bottom lines. However, as for-profit schools will have autonomy to adjust tuition fees at their discretion, some schools may find that the rising costs can be offset by tuition fee increases in the long term.

The choice posed by this amendment raises questions for many schools. Although those that must remain non-profit or those that choose to do will enjoy the same preferential policies as public schools, they will find it more difficult to give their shareholders any form of financial return going forward due to the cancellation of the “reasonable rate of return” policy.

This policy was legalized in 2002 and was intended to give financial incentives for non-profit school owners. However, in order to be eligible to receive funding from some local governments, most private schools actually never took advantage of their right to generate a “reasonable rate of return”. Although by giving up “reasonable rate of return”, some school shareholders were still able to gain “grey income” through various financial vehicles or complicated transactions. Whether the government will tighten regulations on those financial vehicles or not is not yet clear.

Further growth and consolidation of the private education market is expected

Overall, the amendment provides clarity in longstanding grey areas such as who are the legal persons of private schools and who own the schools’ assets etc. Although the private education market will be more regulated, the clarity of regulations may make investors feel more confident in entering this market than before. We expect that a deeper participation of capital markets will help to drive further growth and consolidation of the private education market in China. Possibly the biggest winners from these regulatory changes are those schools offering supplementary, non-degree education, since they do not offer compulsory education the amendment will have minimum negative impact on them.

For additional insight into China’s private education market, download our full report Opportunities for Private Education in Emerging Markets

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