If SC says dataset is not conformant then that means the dataset in PM is not conformant (this message is coming from PM not SC) which means you have a configuration issue somewhere in PM. A dataset must be conformant otherwise we can't register snapshot in PM or do anything.
1. No idea why policy passed to PM is ignored. As you can clearly see SC is passing policy to PM, look at debug and you will see. From our end there is not much more we can do. Maybe this is caused by not running the dataset with the same retention as SC is passing in? I would open case on this. If you can determine SC isn't doing something it should be doing and what it should be doing let us know.
2. You need SC 3.5 for this and you need to re-create dataset with SC 3.5. We were not supporting this feature until 3.5.
Either use GUI, 3.5 will give you option when creating dataset if you want PM to handle primary retention or CLI:
Set NTAP_SNAPSHOT_NODELETE=Y then run --action pmsetup to create new dataset. If the option NTAP_SNAPSHOT_NODELETE=Y is set we set flag so PM can manage primary snapshots.
In SC 3.6 you wont need to re-create dataset to make changes, we can update it