Over-expression of Winged-Eye (WGE) in the Drosophila eye imaginal disc induces an eye-to-wing transformation. Endogenous WGE is required for organ development, and wge-deficient mutants exhibit growth arrest at the larval stage, suggesting that WGE is critical for normal growth. The function of WGE, however, remains unclear. Here, we analyzed the subcellular localization of WGE to gain insight into its endogenous function. Immunostaining showed that WGE localized to specific nuclear foci called the histone locus body (HLB), an evolutionarily conserved nuclear body required for S phase-specific histone mRNA production. Histone mRNA levels and protein levels in cytosolic fractions were aberrantly up-regulated in wge mutant larva, suggesting a role for WGE in regulating histone gene expression. Genetic analyses showed that wge suppresses position-effect variegation, and that WGE and a HLB component Mute appears to be synergistically involved in heterochromatin formation. Further supporting a role in chromatin regulation, wge-deficient mutants showed derepression of retrotransposons and increased γH2Av signals, a DNA damage marker. These findings suggest that WGE is a component of HLB in Drosophila with a role in heterochromatin formation and transposon silencing. We propose that WGE at HLB contributes to genomic stability and development by regulating heterochromatin structure via histone gene regulation.