The thalamic complex is the major sensory relay station in the vertebrate brain and comprises three developmental subregions: the prethalamus, the thalamus and an intervening boundary region - the zona limitans intrathalamica(ZLI). Shh signalling from the ZLI confers regional identity of the flanking subregions of the ZLI, making it an important local signalling centre for regional differentiation of the diencephalon. However, our understanding of the mechanisms responsible for positioning the ZLI along the neural axis is poor. Here we show that, before ZLI formation, both Otx1l and Otx2(collectively referred to as Otx1l/2) are expressed in spatially restricted domains. Formation of both the ZLI and the Irx1b-positive thalamus require Otx1l/2; embryos impaired in Otx1l/2 function fail to form these areas, and,instead, the adjacent pretectum and, to a lesser extent, the prethalamus expand into the mis-specified area. Conditional expression of Otx2 in these morphant embryos cell-autonomously rescues the formation of the ZLI at its correct location. Furthermore, absence of thalamic Irx1b expression, in the presence of normal Otx1l/2 function, leads to a substantial caudal broadening of the ZLI by transformation of thalamic precursors. We therefore propose that the ZLI is induced within the competence area established by Otx1l/2, and is posteriorly restricted by Irx1b.