The rumours I hear is that Apple's drives have firmware to optimise their use with HFS+. Regular drives are allegedly optimised for Windows environments.
However, since we are talking about a fileserver, there's little benefit here.
I regularly swap in larger, stock standard, SATA drives into various Macs, including the Xserves. Pretty common, really. The tray caddies are proprietary, which for a long time was all too common in server hardware across the board (I have caddies for Dells, HPs and IBM servers, some which take SCA-2 or SATA drives which was meant to resolve that very issue, but I digress).
You need to make sure you get the right sled for the right xserve. I think the G5 and Intel trays are physically the same connector, but electrically incompatible. According to Apple there are also differences between the various Intel models. And some drives do have issues with the SATA controller on G5s, or the other way round. Usually, there is a jumper setting to fix this. xlr8yourmac.com often has info on these jumper settings. They used to have an excellent drive compatibility database, but it looks to have died.
So getting back to the question, yeah 2TB drives work. I've not gone larger, but from what I hear the G5 Xserves happily take 3TB+ drives. And thanks to the easily re-routable SATA cables, you can use whatever controller you like. From memory, I think there can be delay booting if the system doesn't detect anything connected to the onboard SATA ports, but that may be resolvable with an Open Firmware setting.