Polygenic type 2 diabetes in mouse models is associated with obesity and results from a combination of adipogenic and diabetogenic alleles. Here we report the identification of a candidate gene for the diabetogenic effect of a QTL (Nidd/SJL, Nidd1) contributed by the SJL, NON, and NZB strains in outcross populations with New Zealand Obese (NZO) mice. A critical interval of distal chromosome 4 (2.1 Mbp) conferring the diabetic phenotype was identified by interval-specific congenic introgression of SJL into diabetes-resistant C57BL/6J, and subsequent reporter cross with NZO. Analysis of the 10 genes in the critical interval by sequencing, qRT-PCR, and RACE-PCR revealed a striking allelic variance of Zfp69 encoding zinc finger domain transcription factor 69. In NZO and C57BL/6J, a retrotransposon (IAPLTR1a) in intron 3 disrupted the gene by formation of a truncated mRNA that lacked the coding sequence for the KRAB (Krüppel-associated box) and Znf-C2H2 domains of Zfp69, whereas the diabetogenic SJL, NON, and NZB alleles generated a normal mRNA. When combined with the B6.V-Lep(ob) background, the diabetogenic Zfp69(SJL) allele produced hyperglycaemia, reduced gonadal fat, and increased plasma and liver triglycerides. mRNA levels of the human orthologue of Zfp69, ZNF642, were significantly increased in adipose tissue from patients with type 2 diabetes. We conclude that Zfp69 is the most likely candidate for the diabetogenic effect of Nidd/SJL, and that retrotransposon IAPLTR1a contributes substantially to the genetic heterogeneity of mouse strains. Expression of the transcription factor in adipose tissue may play a role in the pathogenesis of type 2 diabetes.