The Government and the life insurance industry have squared off in what could prove to be the most important debate in the long-running Mandatory Provident Fund (MPF) saga. The question of restrictions on investment of the $40 billion a year fund pouring into the coffers of the fund management industry was always going to be vexed. Just how unhappy the territory's fund managers are becoming was evident this week when their normally measured tones gave way to something close to the language of confrontation. The Government's plans to restrict asset classes and sectors was, the Hong Kong Federation of Insurers claimed, both paternalistic and anti-competitive. Until now there has been widespread support for, and involvment with, the Government in most aspects of the scheme. The issue which is dividing former allies is simply one of how best to protect the interests of the territory's future pensioners. The MPF, when introduced, will extend pension coverage from about 600,000 to more than three million. Employees and employers will both have to contribute about 5 per cent of the employee's cash income to the scheme up to a ceiling of $20,000 a month. A defined contribution scheme places enormous importance on the skill of the person managing the assets to generate the best returns. Final pay-outs will be a combination of the joint employee-employer contributions and the returns on their capital. This is particularly so in a high inflation environment such as Hong Kong where traditional interest bearing accounts are easily outpaced by rises in the cost of living. The pressure on fund managers to perform will be high because of the intense competition for mandates and increasingly sophisticated performance monitoring. To generate better-than-inflation returns the managers of the funds are going to have to take risks. The question for the regulators is how much risk should scheme members be exposed to. The Government believes that a lower level of risk is acceptable than what the institutions who will be managing the funds - banks, unit trust companies, life insurance companies - think is reasonable. To this end it is aiming to try to limit the risk by establishing a definitive list of authorised investments. It claims there can be a half-way point between minimising risk while maximising return. The list has yet to be announced but is likely to restrict foreign currency exposure, investments in property, debt and use of derivatives. For their part, the life insurers are claiming that Hong Kong should stay true to its values and let market forces reign. Fund managers who provide the best returns will continue to get the mandates while those that fail to perform will lose market share, they claim. Another complaint is that restricting investments also will hamper competition as most companies will offer types of funds that are too similar. It also will present the territory's lawyers with a growth industry finding loopholes to dodge the rules, they claim. The Government's concern is clearly justified after the sorry saga of abuse and scandal that has blighted occupational pension schemes in Britain. Of course, a final assessment of the Government's proposals awaits the publishing of the investment list. Pension officials should also look to the battery of defences offered by existing laws. It seems perverse that when other countries, such as Canada, Britain and Japan, are liberalising restrictions that Hong Kong - the purported paragon of free market capitalism - should be moving the other way. Placing an onus on trustees and managers to state investment objectives and strategies provides an easier method of monitoring risk. Those that overstep that mark could quickly find themselves falling foul of their over-riding legal obligation to act prudently.