The Kex2 protease of the yeast Saccharomyces cerevisiae is the prototype of a family of eukaryotic subtilisin homologs thought to process prohormones and other precursors in the secretory pathway. Deletion analysis of Kex2 protease shows that a sequence of 154-159 residues carboxyl to the subtilisin domain is essential for the formation of active enzyme. Disruption of this region, termed the 'P-domain', blocks the normally rapid intra-molecular cleavage of the N-terminal pro-segment of pro-Kex2 protease in the endoplasmic reticulum (ER). The C-terminal boundary of the P-domain coincides closely with the endpoint of similarity between Kex2 protease and its mammalian homologues. The conservation of and functional requirement for the P-domain sharpens the distinction between a 'Kex2 family' of processing enzymes and degradative 'subtilases', and implies that the Kex2-related enzymes have in common entirely novel structural features that are important in the maturation of precursor polypeptide substrates. Failure to cleave the N-terminal pro-domain, due either to truncation of the P-domain or to mutation of the active site histidine or serine, results in stable, intracellular retention of pro-enzyme, apparently in the ER. Thus pro-Kex2 protease appears to contain an ER retention signal which is removed or destroyed by cleavage of the pro-domain.