Instead of gear loss how about a less harsh outcome?

[Madruk]

You don't have to run around in suboptimal gear, you can buy gear always for you level and convert that into materia if you want. Also some may have two sets of gear, one they normally use and another for conversion.

That's fine for NQ gear, because if you're using a NQ weapon as your best weapon you could care less about converting it. But later down the road as players reach 50 and focus more on HQ/dungeon gear that becomes more valuable, you won't be using it because you'll want materia. You'll instead be using something of lesser value and effectiveness.