For anyone who is interested, I found some helpful workarounds here: https://www.reddit.com/r/MacOS/comments/qj8ndg/onedrive_on_monterey_uses_apples_file_provider/
It's an official MS post, but the comments are where I found the useful information. May also be the post others have referred to (I'm new around here).
Haven't tried this, but another storage vendor with a better Files On Demand implementation: https://tresorit.com/business?dnc=&utm_term=tresorit&gclid=CjwKCAiAyPyQBhB6EiwAFUuakrJPIkv0BNnCA6JI8jgqzOoLQpaIaTpvAQE3gVRF_9JSGi06ZVlfTRoCbuEQAvD_BwE
I'm in the IT at a large academic medical center, and we're a MS first shop. I'm seriously glad our current cloud file solution is Box, because this would have been a support nightmare. Box has been annoying with its push to move users to Box Drive (which forces Files on Demand even under windows), but so far they've been wise enough to continue to support Box sync (which is similar to the old OneDrive behavior). I was completely blindsided by this on my home M1 Mac Mini—it broke Time Machine backups, Spotlight, and even the trashcan. It even broke a little utility I run on my AppleTV to show photos stored on my Mac. On the bright side, Carbonite apparently is smart enough to request the cloud version of a file if it isn't cached locally, so at least I have that backup.
I've researched the workarounds and found the shadow folder on my external drive, but I can't consistently make files stay local—the sync code appears to be badly broken. Until I can do that, I'm not sure I can even switch to another cloud storage provider. I can't reliably download half a terabyte of data from OneDrive to move it to another service. I feel like I'm twisting in the wind until MS fixes this—I put up with some weirdness on Mac, because I figured MS was reliable. Guess I was wrong.