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The specification for unparsed-text contains the following sentence: The $encoding argument, if present, is the name of an encoding. The values for this attribute follow the same rules as for the encoding attribute in an XML declaration. Firstly there is a copy-paste error ($encoding is an argument, not an attribute), and secondly there is no mention of which error code should be raised.
At the 20 May 2010 meeting the XSLT WG meet and approved the resolution of this bug. There is a copy and paste error that will be corrected. We do have an error code - 1190 - for encodings that are not supported by the implementation. This error code should also include the case where the encoding asked for is not of the correct syntax. This will be made clear in the text. This will be closed as part of the errata review process.
This will be erratum E46.