Your XML is not well-formed, a < character must always be escaped as <.
But your stylesheet is a bad example of tag abuse. There's no need and no good reason to use disable-output-escaping here, or to write start and end tags rather than writing nodes. In fact, I think your transformation is nothing more than
<xsl:template match="*">
<xsl:copy>
<xsl:copy-of select="@*"/>
</xsl:copy>
<xsl:apply-templates/>
</xsl:template>
Michael Kay
http://www.saxonica.com/
Author, XSLT Programmer's Reference and XPath 2.0 Programmer's Reference