You will meet Daud in Mission 7: The Flooded District. After you escape from captivity and make your way to his lair you will come upon him in his study. In order to actually spare him you must do one of two things:
Pickpocket him and flee without ever having been seen.
If you render Daud unconscious and then loot him it will not earn you the trophy.
Fight him and let him live once you surrender.
If you knock him out with a dart or choke it will not count as a fight, therefore not unlocking the trophy.
After you spare him using either of the above methods you must exit the area by entering the Gateword Tunnel. Once the area loads the trophy will unlock.
To see the pickpocket method of unlocking the trophy, please view the video below: