OBJECTIVE Mesenchymal stem cells (MSCs) are known to be capable of suppressing immune responses, but the molecular mechanisms involved and the therapeutic potential of MSCs remain to be clarified. RESEARCH DESIGN AND METHODS We investigated the molecular mechanisms underlying the immunosuppressive effects of MSCs in vitro and in vivo. RESULTS Our results demonstrate that matrix metalloproteinases (MMPs) secreted by MSCs, in particular MMP-2 and MMP-9, play an important role in the suppressive activity of MSCs by reducing surface expression of CD25 on responding T-cells. Blocking the activity of MMP-2 and MMP-9 in vitro completely abolished the suppression of T-cell proliferation by MSCs and restored T-cell expression of CD25 as well as responsiveness to interleukin-2. In vivo, administration of MSCs significantly reduced delayed-type hypersensitivity responses to allogeneic antigen and profoundly prolonged the survival of fully allogeneic islet grafts in transplant recipients. Significantly, these MSC-mediated protective effects were completely reversed by in vivo inhibition of MMP-2 and MMP-9. CONCLUSIONS We demonstrate that MSCs can prevent islet allograft rejection leading to stable, long-term normoglycemia. In addition, we provide a novel insight into the mechanism underlying the suppressive effects of MSCs on T-cell responses to alloantigen.