Just reading through RFC6575 - ARP Mediation for IP Interworking for L2VPNs, and noticed that the Cisco implementation doesn't seem to be as mentioned in the RFC.
The CE (CE1) router with Ethernet L2 Attachment Circuit when performs ARP for remote CE IPv4 address, the local PE router responds with its own MAC Address. And that's where IOS stops following the RFC.
As per the RFC, the local PE router when learns about the local CE IP address, advertises that to remote PE router in IP Address List TLV in LDP Label Mapping message. I dont see any Label Mapping messages.
Also, the PE router learns the IPv4 address of CE (CE2) router connected via a PPP L2 Attachment Circuit when the CE router sends a CONFREQ message to PE with its IP address. This PE router then advertises that to remote PE router in IP Address List TLV in LDP Label Mapping message. I dont see that either.
Question is - do the PE routers just forward everything to remote PE after removing the L2 header?