MO allows people to group mods installations into profiles. That way you can have separate mod collections without having to reinstall Skyrim.
Each profile comes with its own set of ini files. MO shows Skyrim the ini files it uses. From Skyrims perspective they are the ini files from the my games directory. As far as it knows.
If you wanted to use the My Games ini files you would start Skyrim through the launcher.
From the MO nexus page:
Mod Isolation (1):
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What mod isolation means is that each mod is installed into its own directory outside the actual data directory.
Through some magic MO then shows the game (and any other 3rd party tool that works on the data directory) a "virtual"
data directory that is a merger of the actual data directory and all the mod directories.
This way no file ever get overwritten when you install a mod and your data directory can remain in a vanilla state.
You can simply change the "installation order" of mods from the gui and deinstall or temporarily deactivate one
without breaking other mods.
More Info on MO: http://wiki.step-project.com/Guide:Mod_Organizer#Profiles_2