Walls – How to repair fiberglass wallpaper with holes in it

I don't think sanding the surface will produce a surface good enough to paint. It's certainly a lot of effort for uncertain results.

If the underlying surface is very rough it might still show through the wall paper, unless it's very thick (1000 gsm lining paper for example) or you do some sanding.

The best answer might be to continue to peel off the paper and then skim the wall with plaster. Depending on your plastering skills you might want to get a professional in.

The result should be good enough to paint.

You should not do this. Foam insulation (EPS, XPS, etc.) needs to be covered with drywall in order to protect it (extend the amount of time before it melts) from fire. Otherwise you are risk of being exposed to toxic fumes and melting foam should you ever have a fire. Imagine molten foam dripping from your ceiling onto you - not a situation you want to find yourself in.

The correct "solution" is to drywall on top of the foam (using furring strips, or long screws into the studs), mud/tape the drywall, prime, and then apply wall paper using standard wall paper adhesives.