who's singing over there?
___ is my sister.
she, that, it choose which？

Veja uma tradução

Technically they are both understandable. However context is important. If the sister is not within eye sight of the speakers, She is my sister makes less sense than "That is my sister." "That" refers to the sound being heard more so than the sister herself.

What do I hear? Is someone singing? Who is that singing?

Oh, that noise you hear, that is my sister.

It's really hard to say because they both make sense. I asked my mother who teaches english and even she was confused as to which was more appropriate.

Typically:
Who? = She/Him/They/We
What? = That/it/the

I hope this isn't for a test because the question seems like a trick.