You need to parse the string, to turn it from lexical XML into a tree of nodes. There's no standard way of doing it within XSLT. In Saxon you can call the saxon:parse() extension function; in other environments you could write your own extension function (for example in Javascript) to invoke the XML parser.
Michael Kay
http://www.saxonica.com/
Author, XSLT Programmer's Reference and XPath 2.0 Programmer's Reference