It's basically a set of three default settings for the gameplay settings. Hard puts a tick in all the boxes, e.g. No event camera, No External Camera, Dud torpedoes manual TDC etc.
It does not affect the ships you will encounter, nor, I believe, does it affect destroyer detection effectiveness or damage done / taken by weapons.
If you want to have a custom campaign difficulty, you can change it in the office room, it's one of the books on the left hand side where load/save are.
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