Sometimes it's very tricky to know what to do as a parent when loved ones - especially daughters - are involved. You've put so much time and effort into raising them right you feel like rock bottom when you find out what they've been up to.
I'm a father of two teenage sons and I've had some interesting times trying to dissuade one of them from a certain habit he got into.
You have to calmly and sincerely approach both of these young people and try to get things out in the open, especially for the young nephew and his mother's sake. I found keeping things under wraps was not the way forward. I think you should get talking, quietly and helpfully, with everyone concerned. The sooner the better.
You'll start to feel better, your sister will appreciate you clearing the air and the young people involved will listen up because you care. Keep at it, persist and try to gain trust all round.
I wish you well. You have to get this issue out in the open but you'll need tact and understanding. Eventually you may need an agreement of sorts, verbal or otherwise.