Heterochromatin protein 1 (HP1) is localized at heterochromatin sites where it mediates gene silencing. The chromo domain of HP1 is necessary for both targeting and transcriptional repression. In the fission yeast Schizosaccharomyces pombe, the correct localization of Swi6 (the HP1 equivalent) depends on Clr4, a homologue of the mammalian SUV39H1 histone methylase. Both Clr4 and SUV39H1 methylate specifically lysine 9 of histone H3 (ref. 6). Here we show that HP1 can bind with high affinity to histone H3 methylated at lysine 9 but not at lysine 4. The chromo domain of HP1 is identified as its methyl-lysine-binding domain. A point mutation in the chromo domain, which destroys the gene silencing activity of HP1 in Drosophila, abolishes methyl-lysine-binding activity. Genetic and biochemical analysis in S. pombe shows that the methylase activity of Clr4 is necessary for the correct localization of Swi6 at centromeric heterochromatin and for gene silencing. These results provide a stepwise model for the formation of a transcriptionally silent heterochromatin: SUV39H1 places a 'methyl marker' on histone H3, which is then recognized by HP1 through its chromo domain. This model may also explain the stable inheritance of the heterochromatic state.