My dictionary gives as definition of a separate word, the Latin "pace", the ablative of "oax".
It is used to indicate polite disagreement, as in:
"A good example of this process is the widespread adoption of---pace the House
of Lords--- "gay" usage." (in reference to previously mentioned complaint by a member of the
House of Lords that poets could no longer use the word "gay" in its old sense)

My dictionary says that "pace" is a preposition. Please, someone whose command of grammar
is greater than mine, explain how it is a preposition.

A preposition introduces a noun or nounal phrase. Pace, in the example you give, Bill, introduces the House of Lords (as if the antediluvian muggers pardon the cross threading :-)) need any introduction!!!) in that sentence. It is, therefore, playing the part of a preposition just as much as if you had said in or at the House of Lords.

Dear RC: I had my nose too close to the grindstone, and failed to think of literal meaning
of "preposition. But I think the use of the word in this instance a bit inkhorn, almost a
sneer, being addressed to the House of Lords, when an opinion of only one member
was considered.

Yep - I think you're dead right on that. The use of pace in the case quoted is practically an insult!

Except that it's almost impossible to insult the House of Lords

Dear RC: Peace be unto the House of Lords. In fact, peeees all over them.
However I also resent the misuse of a fine word to describe a foul faction.
I had friends who formed a club in the forties called "The GaY Fifties"
because they were all a bit over fifty years old.
They found themselves in a few years ridiculed by teenagers.
And I knew several families named Gay who must have resented the change.

Except that it's almost impossible to insult the House of Lords

Almost?