HLA-DM catalyzes peptide loading and exchange reactions by MHC class II molecules. Soluble recombinant DM, lacking transmembrane and cytoplasmic domains, was observed to have 200- to 400-fold less activity compared with the full-length protein in assays measuring DM-catalyzed peptide dissociation from purified HLA-DR1 in detergent solutions. Additional studies with truncated soluble DR1 demonstrated that transmembrane domains in DR1 molecules are also required for optimal activity. The potential requirement for specific interaction between the transmembrane domains of DM and DR was ruled out in experiments with chimeric DR1 molecules containing transmembrane domains from either DM or the unrelated protein CD80. These results suggested that the major role of the transmembrane domains is to facilitate colocalization of DM and DR in detergent micelles. The latter conclusion was further supported by the observation that HLA-DM-catalyzed peptide binding to certain murine class II proteins is increased by reducing the volume of detergent micelles. The importance of membrane colocalization was directly demonstrated in experiments in which DM and DR were reconstituted separately or together into membrane bilayers in unilamellar liposomes. Our findings demonstrate the importance of membrane anchoring in DM activity and underscore the potential importance of membrane localization in regulating peptide exchange by class II molecules.