The function is CalculateNextWorkRequired in pow.cpp L#49:

unsigned int CalculateNextWorkRequired(const CBlockIndex* pindexLast, int64_t nFirstBlockTime, const Consensus::Params& params)
{
    if (params.fPowNoRetargeting)
        return pindexLast->nBits;

    // Limit adjustment step
    int64_t nActualTimespan = pindexLast->GetBlockTime() - nFirstBlockTime;
    if (nActualTimespan < params.nPowTargetTimespan/4)
        nActualTimespan = params.nPowTargetTimespan/4;
    if (nActualTimespan > params.nPowTargetTimespan*4)
        nActualTimespan = params.nPowTargetTimespan*4;

    // Retarget
    const arith_uint256 bnPowLimit = UintToArith256(params.powLimit);
    arith_uint256 bnNew;
    bnNew.SetCompact(pindexLast->nBits);
    bnNew *= nActualTimespan;
    bnNew /= params.nPowTargetTimespan;

    if (bnNew > bnPowLimit)
        bnNew = bnPowLimit;

    return bnNew.GetCompact();
}

Explanation:
1. If retargeting is disabled, return the last difficulty.
2. Calculate the timespan between the last block and 2016 blocks ago
3. Truncate the timespan to no less than 1/4 of the target timespan (3.5 days) or no greater than 4x the target timespan (8 weeks).
4. Multiply the last difficulty target by the ratio actualTimespan:targetTimespan
5. Truncate to the maximum allowed target (bnPowLimit) if the resulting target is too high (very low difficulty)