Nice writeup, Stormborn. Lotta good ideas, there.
GMSkarka, I don't know how much of a fleshed-out setting you might already have in mind, but I've reflexively started coming up with a world to fit the images that "wuxia/western" conjures up for me. I think the most vital thing is that the setting needs to be a frontier--a place distant from any powerful authority--and probably one that's mostly arid and barren (although there are a whole lot of different terrain types possible within that mandate). It should be a place where people have to work hard to survive, forming close-knit, isolated communities, and the roving gangs of bandits that prey on them.
A few people have said things to the effect of "What will you do with the elves?", and my instinct is just to leave them out entirely. I don't see any need for non-human PC races, here. Instead, I'm picturing a landscape of multi-ethnic and culturally-diverse humanity. The setting concept that springs to mind, actually, is one where humans--maybe even whole towns--from Earth have been falling through holes in reality into some harsh alien world for generations, and people from all over our world have built a new civilization--or civilizations--in that world. Maybe holes stopped occurring a long time ago, even, because I'm not really interested in imagining this as a "regular folks dumped into crazy alien world" scenario, just in appropriating a bunch of cultural elements from Earth and mashing them together somewhere else.
So, technology and the people who know how to work with it have been falling through to this new world (maybe up until the late 1800s), but it's a brutal environment with few natural resources and little to no centralized authority: still basically a frontier. The basic infrastructures of civilized life and mass production haven't really had a chance to take root, so far. Without the power of machines and legal authority around, the personal power of martial arts looms large in the world, and has effected the new civilization strongly. Monastaries with their roots in ancient China are major power centers and cultural influences.
Eventually, people discover how to make a gunpowder-equivalent with materials from the new world, and revolvers, rifles, and shotguns similar to those of the American West begin to reappear. This shakes things up for a little while, maybe shatters some of the existing structures, but eventually guns become a part of the world's culture, as much a weapon of mystics and martial artists as the sword ever was.
Aside from the descendants of plane-lost Earthlings, the world could be populated with all kinds of interesting things. You could throw in an intelligent indigenous species or two--maybe even D&D demihumans, if you really want--to fill in the role of the Indian in western stories: Alien, mystical, primitive, traditional, and at perfectly home in the same world other consider a hostile frontier. They'd also be the natural way to insert some magic into the setting, if you really want (personally, I'd rather stick to just qi and kung fu). (Or, for that matter, maybe the natives died out long ago, leaving behind ruins full of strange artifacts, and giant statues half buried in the desert.) Also, of course, the world can be populated by loads of weird monsters (once again, regular D&D stuff can work fine, here).
For mechanics, I'm totally with Stormborn on the idea of having players choose a code of honor for their characters, and give rewards for upholding it. Mind you, these codes don't have to be good and righteous moralities, just rules that characters try to live by, like "I avenge every slight done to myself in kind." or "I never pass up an opportunity for profit without honest work."
The rewards for following these, naturally, would be some kind of action points. And, naturally, action points are hugely necessary for supporting wuxia-style combat. Give out lots of action points which can be spent on lots of different things (like the usual d20 roll bonuses and get-out-of-death-free stuff, but maybe also things like the use of a feat that you don't actually have--but do qualify for--for one round).
Also important to wuxia combat would be a stunt system of some kind: Lots of combat uses for skill checks, bonuses on checks for interesting ideas and cool action descriptions, etc. I'd suggest implementing a maneuver system like the one in The Book of Iron Might and Iron Heroes. An alternate critical system might also be good, where instead of double damage, a character can use a crit to add some additional effect to an attack.
Something like Iron Heroes' token pools also might be the best way to do a qi system: Characters start each fight with a number of qi points based on their level/class/feats, but can replenish these in the middle of combat by taking a moment--and sacrificing actions--to focus themselves.
I get the impression you'd rather work with the base classes and just add some feats, rather than come up with a whole replacement PHB, like Arcana Evolved and Iron Heroes. I think that can work, but it can't really be optimal. I dunno. My idea of this whole concept is probably just further from D&D than you're really intending to go.
Whichever way you go, I think a book like this would have to rely strongly on art to get its flavor across to players. Illustrations of characters that embody at once both western and wuxia themes are extremely necessary, and shots of the world itself--both the wilderness and what passes for civilization--are probably just as important.