N.
While this may not fully answer your question, my main advice is don't go against your sister's choices when it comes to how she chooses to raise HER own children as long as she isn't being abusive, which based on what you described does not seem to be the case. My husband and I had very strong opinions about how we should raise our older son and my best friend, who was a very close family friend, disagreed with our choices. She intervened and essentially drove a wedge between our oldest son and us that has never been repaired. In hindsight, everyone involved now sees that our decisions were the right ones as our son has gone on to far worse situations as a result of that one bad choice, but there is nothing any of us can do to turn back time. She and I are still friends, but by no means best friends anymore. She way overstepped her boundaries when she got in the middle of the situation and now all of us, especially our son, are suffering the consequences of it.
I think it's ok for you to voice your opinion TO YOUR SISTER, NOT HER DAUGHTER, about what you think is the better way to handle the situation, but if your sister disagrees, it would probably be best just to do what you can to support her, not go against her. Parents aren't always right, but they almost ALWAYS have the child's best interest at heart. People who are not the parents think they know best, but they can often have opinions that are clouded by other issues they have with the parents, and in the end, those "ulterior motives", even subconscious ones, can hurt everyone involved. The parents also may have more knowledge about the situation that you may not be aware of, so you might be making judgments without all of the facts.
I would let your sister and her husband handle their own children in their own way. If they make a mistake, they will get through it and won't have anyone else to blame. If you try to change things because you think you know better, you will most likely regret it in the long run and could cause a lot more heartache for everyone involved than leaving the issue alone would have done to begin with.
The one thing that plays over and over in my mind from the time that we had the major breakdown with our son because of my best friend's interference was what would she have done if it was her child and we were the ones interfering with her choices? You love your niece, but she's your niece, not your daughter. Let her mom and dad be the parents.
Blessings,
N.