Currently, the display name is not what is shown in the People tab. If a student is transitioning and wants only the new preferred (but not yet legal) name to be seen by other students, there is not a way to accomplish this, if the users' ability to edit their profile name has been disabled. For example, if John Michael now goes by Cynthia, the other students see the Display name (Cynthia) in discussion boards and Inbox, but the legal name (John Michael) still shows on the People tab. This negates the purpose of the Display name. The Display name should show in any place that is visible to other students. Of course, this is equally applicable to instructors' display names.
The legal name would still show in Grades and Attendance so there wouldn't be any issues with transcripts.