If the law were to be passed, surely Photon would be incentivized to make a self-hosting alternative, no? Something that uses the same API but is self-hosted.

There is no indication that a self-hostable alternative that to what Photon is providing is even feasible, as a lot of what they are doing includes tuning network settings, setting up CDN-like structures, etc.. Even for their enterprise offerings they are targeting a managed cloud approach, and not an independently deployable binary.

If the law were to be passed, Photon would at the maximum be incentivized to produce a self-hostable API-compatible alternative that would be neutered to such a degree that Games still qualify as "playable" on paper but would be unenjoyable to actually play. More likely, they won't do anything, as they are not the game developer and not responsible for compliance.