Islet transplantation has been established as a viable treatment modality for type 1 diabetes. However, the side effects of the systemic immunosuppression required for patients often outweigh its benefits. Here, we engineer programmed death ligand-1 and cytotoxic T lymphocyte antigen 4 immunoglobulin fusion protein-modified mesenchymal stromal cells (MSCs) as accessory cells for islet cotransplantation. The engineered MSCs (eMSCs) improved the outcome of both syngeneic and allogeneic islet transplantation in diabetic mice and resulted in allograft survival for up to 100 days without any systemic immunosuppression. Immunophenotyping revealed reduced infiltration of CD4 or CD8 T effector cells and increased infiltration of T regulatory cells within the allografts cotransplanted with eMSCs compared to controls. The results suggest that the eMSCs can induce local immunomodulation and may be applicable in clinical islet transplantation to reduce or minimize the need of systemic immunosuppression and ameliorate its negative impact.