This is a critical step that requires some care and, possibly, some experimentation. The aim is to remove the large number of telluric lines that appear in IR spectra. This is done by dividing the object spectrum with that of a telluric standard. Since this is a division of one spectrum by another, it is important that the strength, shape and centroid of the telluric lines match.
First and foremost, the telluric standard and the object have to observed with the same instrument setup, with roughly the same airmass and, if possible, consecutively.
Secondly, the object and science data should be reduced in the same way and with the same calibration frames.
For the best results, one may have to modify the spectrum of the telluric standard so that the center and strength of the telluric lines match those of the object spectrum.
The next step is to remove spectral features that have been imprinted onto the object spectrum from the telluric standard itself.
Telluric standards are either hot stars or solar type dwarfs. Both types contain spectral features that should be removed. For solar type stars, one can use the observed solar spectrum to remove the features. This can be tricky if the spectral resolution of the instrument is a function of the wavelength (which is the case for ISAAC) as it means that the kernel for convolution also has to be a function of wavelength. The arc spectra and the OH lines can be used to estimate what this function is.
Hot stars usually contain helium and hydrogen lines. If the spectral regions around these lines are of interest, then one should think carefully about using these type of stars. If the resolution is high enough, which is certainly the case for MR observations, one can try to remove these lines by fitting them. Alternatively, one can use a second telluric standard that does not have helium or hydrogen lines so that these lines can be removed from the hot star.
The ISAAC FITS header does not always contain the full target name of the telluric standard and, sometimes, operators forget to include it in the night report. To find out which telluric standard was used, look at the RA and DEC of the target and consult either the ISAAC manual or the list of Hipparcos stars that are often used as telluric standards.