You're right, the game loads lower res textures for the other players:
That makes sense now
There's one more part to it that I'm pretty sure of.
The game loads the hi-res textures for whatever armor or parts of armors you're wearing, so this applies to other people wearing the same parts you're wearing.
For example if I'm not wearing my Kibelius outfit and go stand next to someone who is wearing the winged version, it looks like the original costume. But if I then put my Kibelius outfit on which has the wings removed and shows mega-tansparency, the person beside me instantly loses their wings and goes transparent too.
So it's every texture you're not wearing that the game defaults to the low-res version, but this explains why from time to time you happen across someone with the same hi-res mod that you have.
And for sure we can spend the time to gather the filenames for all the low res costumes and overwrite the modded hi-res textures onto them (this must include basebody and underwear), then everything will be changed for everyone... but oh my, what a drag to do all that work :P