For the record, this prevents any usage of the RichText editor. For the potential users searching for the exception message, in PlatformUI the save draft REST request ends with a 406 with the message: Argument '$inputValue' is invalid: Could not create XML document: Entity 'nbsp' not defined or similar for others entities.
Petar Spanja indeed CKEditor has an option to transform entities into numeric entities but my first quick test was not really successful, but I need to dig a bit more on how to pass CKEditor settings from AlloyEditor. That said, I dont' want to be picky but the format is called "html5edit" not "xhtml5edit". It's not obvious (nor documented anywhere AFAIK) that this should be a well formed XML document. And given how the browsers/rich text editors are working, I'm pretty sure we'll need a bit more flexible/relaxed parser at some point or to introduce some flexibility somewhere.