China is extending its regulatory storm from tech to education

Even before the harsh new rules, there were unmistakable signs Beijing was on the warpath against private educational services. …

Just as China’s regulatory storm against big tech came abruptly and brutally, Beijing’s deepening crackdown on private education companies is plunging the entire sector into an existential crisis.

China’s State Council and the Party’s central committee have jointly issued a set of rules (link in Chinese) aimed at curtailing the sprawling sector that has flourished thanks to massive funding from global investors and ever increasing spending from families fighting to help their children gain a better footing in life. After years of high growth, the size of the after-school tutoring sector has reached upwards of $100 billion, of which online tutoring services account for around $40 billion.

“The timing is also interesting as it coincides with the crackdown on the tech companies, and further confirms the intention of the government to regain control [of] and restructure the economy,” said Henry Gao, an associate professor of law at Singapore Management University, referring to Beijing’s sweeping regulatory overhaul of tech companies including Alibaba and Tencent, which have either been fined for monopolistic practices, ordered to give up their exclusive rights in certain sectors, or, in the case of Didi, have fallen afoul of national security rules.

China’s “double reduction” policy

The rules, released over the weekend, aim to ease homework and after-school study hours for students, which the policy dubbed the “double reduction.” They stipulate that companies teaching subjects covered in primary and middle school, which are compulsory in China, should register as “nonprofit institutions,” essentially banning them from making returns for investors. No new private tutoring firms can register, while online education platforms also need to seek new approval from regulators despite their previous credentials.

Meanwhile, companies are also banned from raising capital, going public, or allowing foreign investors to hold stakes in the firms, posing a major legal puzzle for funds like US firm Tiger Global and Singapore state fund Temasek that have invested billions in the sector. In a further blow to China’s ed-tech startups, the rules also say that the education department should push for free online tutoring services across the country.

The companies are also banned from teaching on public holidays or weekends.

Double-digit reductions in Chinese stocks

The looming rules, first reported by Bloomberg last Friday (July 23), immediately led to a sell-off last week in US-listed veteran education players such as New Oriental Education & Technology and TAL Education. In trading in Hong Kong today, where Oriental floated a secondary listing last year, shares of the company plunged 47% today. Meanwhile, Larry Chen, the former schoolteacher who founded Gaotu Techedu, a major online education player, fell out of the ranks of China’s billionaires.

Major education companies have been quick to say they will comply with the new government rules. New Oriental, the largest Chinese player in this space, said that the new regulations will “have material adverse impact” on after-school tutoring services, a sentiment echoed by TAL.

The regulatory developments also spurred a broader $2 billion selloff in Chinese stocks, as the bar on foreign investment for education firms coupled with the crackdown on foreign IPOs after ride-hailing giant Didi confirmed to foreign investors just how exposed their investments are from China’s regulatory actions. Social media and gaming Tencent was down 7.7% in Hong Kong today after China told it to unwind its monopoly on exclusive music licensing rights, while food delivery giant Meitu was down nearly 14% after Chinese regulators today ordered better protections for delivery workers.

Why is China cracking down on education?

While the harshness of the new measures is surprising, the fact that they were coming wasn’t. In March, president Xi Jinping called after-school tutoring services a “social problem,” and in May he again lashed out at the industry’s “disorderly development.” Following Xi’s criticism of the sector, authorities set up a dedicated department to supervise it, including examining tutor qualifications and fees, as well as imposing a ban on teaching preschoolers primary school materials.

In addition to Beijing’s desire to put the brakes on tech sectors that it believes expanded too chaotically, the turn to education indicates the government’s worries about China’s dropping birth rate. One of the major purposes of the new rules is to “effectively ease the anxieties of parents,” as well as reduce family spending on education, according to the government document. A major obstacle for Chinese citizens to have more than one child is the sheer cost of doing so, and in particular the difficulty of securing a quality education, which authorities promised to address in May, when introducing the third-child policy.

One Chinese teacher Quartz spoke to noted that it may be middle-class families who feel this policy the most, given they are most likely to push their kids into tutoring. Affluent families, after all, can still engage private tutors or send their children abroad to elite schools.

“The new rules will benefit those who are in the grassroots class that don’t have much time or energy to supervise children’s studies,” said the teacher. “But for people like us who are in the middle-class bracket, we will be hit the hardest.”

The next target of China’s infinite crackdown

The new rules are yet another razor-sharp warning to global investors that high returns from investment in China Inc can turn into huge losses overnight.

Yuanfudao, one of China’s largest online tutoring service startups, raised $2.2 billion in two funding rounds partly led by Tencent in October, pushing its valuation to over $15.5 billion. But now it is unclear what will happen to the stakes held by investment firms, especially foreign ones, after the new rules dashed hopes of cashing out through upcoming IPOs.

“This incident highlights the crucial importance for global investors to have people who understand China, who can decipher investment risks from minor nuances in mundane government documents…Any company that wish to operate in China should put China’s regulatory uncertainties as the biggest risk factor,” said Gao, the professor.

The education sector is not the only one that needs to worry about government scrutiny, however.

On Weibo, many commentators have pointed at the housing market, whose skyrocketing prices have been cited often by citizens as a major difficulty to having children, as the next target of crackdown. In an analysis, Chinese financial columnist Jin Lun argues that any industry that is seen as contributing to people delaying having children will be a potential target. “High housing prices will also be cracked down as an ‘enemy’ that has been weighing down the birth rate. While the industry will continue to exist to meet demand, there is basically no hope of continuing to see housing prices rise,” wrote Jin.

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