It means that it doesn't allow the trachea to open to it's full extent, which means the horse cannot breath as easily. Usually referred to as 'roaring' or 'making a noise'.
I cannot remember how they are graded, but I have a feeling it goes up to grade 4 (someone correct me if I'm wrong).
This article will be able to explain it much better:
http://www.horseandhound.co.uk/horse...370/34656.html