Hello,
I think the solution depends on the used transformation processor. I had no problems using xalan. The error message sounds like something MSXML does – it simply drops the encoding and assumes you know the data comes in utf-16 (if I remember right).
I do not know about saxon if you use that one.
Please repost in “PassThru Servlet, Transformation, XSLT” as I consider this an XSLT issue rather than SXS. I am sure the moderator there can help you. 
Christian
#webMethods#API-Management#Tamino