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Practice Note 12.2 Adequacy of Internal Controls
Report of the Committee and Code of Corporate Governance
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Rule Amendments

  Versions
(1 version)
 
Apr 2 2013 onwards

Practice Note 12.2 Adequacy of Internal Controls

Details Cross References
Issue date: 2 April 2013

Effective date: 2 April 2013
Listing Rules 610(5) and 1207(10)

1. Introduction

1.1 This Practice Note provides guidance on the application of Rules 610(5) and 1207(10).
1.2 Issuers are required to disclose the following in their prospectuses and annual reports:

"Opinion of the Board with the concurrence of the audit committee on the adequacy of the internal controls, addressing financial, operational and compliance risks."

Rule 610(5) requires the disclosure to be made in the prospectus whereas Rule 1207(10) requires the disclosure to be in the annual reports.

2. Intent of Rules 610(5) and 1207(10)

2.1 Internal controls, including financial, operational and compliance controls, serve to safeguard shareholders' investments and company's assets.
2.2 The audit committee is usually responsible for overseeing internal controls. The Board, which includes executive directors, is also responsible for assessing the adequacy of these internal controls.
2.3 The objective of Rules 610(5) and 1207(10) is to increase transparency and accountability. In providing this opinion, the Board and the audit committee are required to demonstrate that they have rigorously assessed the internal controls in relation to all three areas of risk, namely financial, operational and compliance.

3. Compliance with Rules 610(5) and 1207(10)

3.1 In satisfying Rules 610(5) and 1207(10), the Board and the audit committee may ask for an independent audit on internal controls to assure themselves on the adequacy of the controls, or if they are not satisfied with the systems of internal controls.
3.2 The issuer should maintain proper record of the discussions and decisions of the Board and the audit committee.
3.3 Compliance with Rules 610(5) and 1207(10) involves the following disclosures:-
(i) Where the Board and the audit committee are satisfied that the issuer has a robust and effective system of internal controls, the disclosure must include the basis for such an opinion.

To avoid doubt, under Rule 246(9), all listing applicants are required to provide, for the Exchange's assessment, the auditor's report to management on the internal controls and accounting systems. Where weaknesses exist in a potential issuer's internal controls and accounting systems, the Exchange may seek a confirmation from the auditors of the potential issuer that the material weaknesses were addressed. This is in addition to Rule 610(5) which requires the Board and audit committee to disclose the basis for their views on the robustness and effectiveness of the issuer's system of internal controls.
(ii) In relation to Rule 1207(10), where the Board and/or the audit committee is of the view controls need to be strengthened, or has concerns that controls are inadequate, the Board would have to disclose the issues and how it seeks to address and monitor the areas of concerns.

4. Format of Disclosure

4.1 The provision of this opinion has no prescribed format.
4.2 As the Board and audit committee are obliged by Rules 610(5) and 1207(10) to provide the specific disclosures in Paragraph 3.3 above, the Exchange recommends the opinion be provided in the following ways:-
(i) Disclosure to be made in the section on "Audit Committee" or "Internal Controls" of the prospectus for compliance with Rule 610(5).
(ii) Disclosure to be made in the Directors' Report or Corporate Governance section of the annual report for compliance with Rule 1207(10).

5. General Principle

5.1 Good disclosures which comply with Rules 610(5) and 1207(10) comprise the following:
(i) The Directors' opinion on the Group's internal controls addressing financial, operational and compliance risks; and
(ii) The basis for the Directors' opinion.
5.2 Should the Board with the concurrence of the audit committee, disclose that in its opinion, the Group's internal controls has weaknesses, then clear disclosure of these weaknesses and the steps taken to address them is necessary for investors to make an informed decision about the Company.

Added on 2 April 2013.