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Don't hate on Fat Princess, it's a fun game. =)

Microsoft has enough characters to make a crossover fighter, but I don't think they should make one. Fighters are not exactly the games most Xbox-users play.

As for characters:

Master Chief and Arbiter from Halo
Splosion Man from Splosion Man
Azurik from Azurik: Rise of Perathia
Banjo and Kazooie from Banjo Kazooie
Joanna Dark from Perfect Dark
Conker from Conker's Bad Fur Day
Any main protagonist from Fable
The Gunstringer from The Gunstringer
Ilo and Milo from ilomilo
Vince from Voodoo Vince
Frank and the Maw from The Maw
One of the Agent characters from Crackdown
Blinx from Blinx
Any Mech from MechAssault
Kameo from Kameo
Any character from Fuzion Frenzy
A group of Toy Soldiers from Toy Soldiers
Inphyy and Myifee from Ninety-Nine Nights
Moonshade from Crimson Alliance
Arran from NightCaster
Ninja Fu Hiya from Kung Fu Chaos
Shu or whatever his name was from Blue Dragon
Mr. Pants from It's Mr. Pants
A character from lost Odyssey
I'm sure I'm missing something

Add to that a few characters not owned by Microsoft like Alan Wake and some dude from Gears of War and it's a decent roster. It's not like Sony doesn't use third party characters in their game, and even Nintendo did it.