There is no setting that can do this in Joomla 2.5 (as far as I know).
The only think capable of doing such a thing would have to be a system plugin that will re-encode the URLs.
So my first idea would be to check all the System plugins that may be URL related (like SEF things, or redirect plugins or some routing plug in and so on).
If that fails try to disable all System plugins and see if that fixes the issue.
Another way to test is to get a new fresh Joomla install and add one by one the components that you have on the broken install.
PS: Turns out it was a custom system plugin. (see comments)