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USP7, a ubiquitin-specific peptidase (USP), plays an important role in many cellular processes through its catalytic deubiquitination of various substrates. However, its nuclear function that shapes the transcriptional network in mouse embryonic stem cells (mESCs) remains poorly understood. We report that USP7 maintains mESC identity through both catalytic activity–dependent and –independent repression of lineage differentiation genes. Usp7 depletion attenuates SOX2 levels and derepresses lineage differentiation genes thereby compromising mESC pluripotency. Mechanistically, USP7 deubiquitinates and stabilizes SOX2 to repress mesoendodermal (ME) lineage genes. Moreover, USP7 assembles into RYBP-variant Polycomb repressive complex 1 and contributes to Polycomb chromatin–mediated repression of ME lineage genes in a catalytic activity–dependent manner. USP7 deficiency in its deubiquitination function is able to maintain RYBP binding to chromatin for repressing primitive endoderm–associated genes. Our study demonstrates that USP7 harbors both catalytic and noncatalytic activities to repress different lineage differentiation genes, thereby revealing a previously unrecognized role in controlling gene expression for maintaining mESC identity.