Hi cauatc,
If you have a procedural separation (longitudinal or lateral) already established when the transponder fails, even though you may be using radar, then there is no problem. If you don't have longitudinal or lateral, then your only option is vertical separation. You may even have to use emergency separation of 500' as an interim measure until you can safely provide 1,000' separation. Have a look at your China AIP and especially the procedures used by Sanya to provide separation when aircraft deviate off-track during typhoons. It may give you some ideas on how they cope with providing lateral separation between radar identified traffic and procedurally controlled traffic.
On the beach