It needs to be on a long rein, not a loose rein - that's an important distinction. You'll be penalized for dropping the contact.
It's a transition from medium walk to free walk and back to medium walk in the middle of the test, and it's scored with a coefficient of 2, meaning it counts double. It is a test of correct training, because a horse that's been forced into a frame, or trained with devices, will not stretch down into the contact the way the test calls for - they'll either invert, stretch down but avoid contact by going behind the vertical, or just stay in the coerced frame. Also, if they resist in the transition back to medium walk, when you shorten reins and ask them to compress, that's a fault as well.
All this is hard for a horse that's been trained in WP that has a very heightened respect for the bit and wants to "back off" the bit. Even HUS horses that I've seen tend to be ridden with "faux contact" - the rider takes the slack out of the reins and follows the head and neck gestures, but the horse isn't really picking up the other end of the conversation.
FP, the good news is that I know of a really nice QH mare that did a ton of AQHA showing and was probably flatted in draw reins every day of her AQHA life, and she ended up doing very well in dressage with minimal reschooling. In a mild bit and no devices, she did learn to stretch contact pretty readily, and was a fabulous event and lower level dressage horse.
Here's a link to the training level test I http://www.usef.org/documents/discip...aining%201.pdf
I'll try and find one with the scoring rubric, that would be more helpful.