Heparanase is an endo-glucuronidase expressed in a variety of tissues and cells that selectively cleaves extracellular and cell-surface heparan sulfate. Here we propose that this enzyme is involved also in the processing of serglycin heparin proteoglycan in mouse mast cells. In this process, newly synthesized heparin chains (60-100 kDa) are degraded to fragments (10-20 kDa) similar in size to commercially available heparin (Jacobsson, K. G., and Lindahl, U. (1987) Biochem. J. 246, 409-415). A fraction of these fragments contains the specific pentasaccharide sequence required for high affinity binding to antithrombin implicated with anticoagulant activity. Rat skin heparin, which escapes processing in vivo, was used as a substrate in reaction with recombinant human heparanase. An incubation product of commercial heparin size retained the specific pentasaccharide sequence, although oligosaccharides (3-4 kDa) containing this sequence could be degraded by the same enzyme. Commercial heparin was found to be a powerful inhibitor (I50 approximately 20 nM expressed as disaccharide unit, approximately 0.7 nM polysaccharide) of heparanase action toward antithrombin-binding oligosaccharides. Cells derived from a serglycin-processing mouse mastocytoma expressed a protein highly similar to other mammalian heparanases. These findings strongly suggest that the intracellular processing of the heparin proteoglycan polysaccharide chains is catalyzed by heparanase, which primarily cleaves target structures distinct from the antithrombin-binding sequence.