The engine doesn’t currently support 16-bit sRGB textures. When we’re doing the texture compression, all 16-bit textures are sent to the DDC as linear textures, regardless of the sRGB option. However, I suspect that there’s some miscommunication in the pipeline.
When the GPU reads an image that was stored linearly, but the option for sRGB is still true, so it expects that to be the case. As such it effectively double gamma corrects the image (hence the washed-out-ness).